Bull Call Spread

by Nick Hunter

A bull call spread is when you have a long (buy) call option and a short (sell) call and you want the market to rise, hoping the options get exercised or are traded for a profit. Bullish call spread strategies have premium (cost) risk, but in the option world - that is pretty minor. Since one option offsets the other, large or unlimited losses are not usually seen with spread trading.

It's important to understand first that a buy or long call option, by itself - is bullish and a short call by itself - is bearish.

When you own a call option, you are bullish because the contract gives the holder the right to buy the underlying stock at the strike price. When a trader is short a call contract, he is bearish. That is because the investor is obligated to deliver shares of the stock to the call holder when the option is exercised. This usually results in a loss for the seller, as the market will be higher to get the stock and it's being sold at a lower strike price.

A spread takes those 2 positions and has them work together. Although, they do not have to get exercised together. A bull call spread means the contracts are set up in a way that makes strategy profitable only if the market goes up. This also means that the contract bought cost more than the contract sold. Bullish call spreads are also known as call debit spreads.

Example:

Buy 1 SDH Nov 80 Call for $500
Short 1 SDH Nov 90 Call for $200

This is an example of a debit bull call spread. Debit because the investor has lost $300 on the premiums bought and sold. The buy option cost $500 and the short took in $200. Since the trader is very aware of this initial loss, he wants the market to rise so the options have a chance to grow in value. If this happens, the person take advantage of trading opportunities on the more valuable contracts or he can look to exercise both contracts and make a positive spread on the strike prices.

Exercising bull call spreads

Spreads are basically covered options. One option covers the other - but not always for a profit. When it's a bullish call spread, it will be profitable. The buy or long call can be exercised at 80. This means the trader can own the stock itself at $80. If the short call is exercised (called away) at 90, he has a 10 point positive gain on the strike price. The maximum gain for this strategy is 10 points minus the net loss debit of 3 points. So, on one contract each, the maximum profit on this call spread is $700.

The point being, bullish call spreads are only profitable when the market goes up. Otherwise these options would fade out in a declining market and the investor would lose the $300.

Expiring bullish spreads

The worst case scenario with bullish call strategies are the options expiring. It is to the investors advantage the market rises soon after the contracts have been established. That is always the big picture with options. They come and go quick.

Happy Trading

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About author:
Nick Hunter is the President of American Investment Training. Their website http://www.aitraining.com offers investors and brokers with education courses and investment information.

Published under category : Stock Trading