Bull call spreads are also known as call debit spreads. They are a bullish options trading strategy that involves buying a call then selling another call out of the money with the same expiration date. This combination process lowers the break even price on the trade.
Bull call spreads are a bullish option strategy that limits your trading risk. It consists of buying a long call and short call strike with the same expiration date. The short call reduces the theta and delta of your contract. Buy a call and sell a call.
Bull call spreads have many names. In fact, bull call debit spreads, long call spreads, vertical spreads are all common names used to refer to the same options strategy. Put simply, you’re just buying and selling a call.
It’s referred to as a bull call debit spread because a debit is taken upon entering the trade. Sounds exciting, doesn’t it? Well, it should be. Because regardless of where you are in your trading journey, learning how to build bull call spreads will be a powerful tool in your trading toolkit. Keep reading and I’ll show you how bull call spreads can work for you!
A bull call spread is the strategy of choice when investors feel the price of the underlying asset (ie. commodities, bonds, stocks, currencies, etc) will only go up a small amount in the near future.
High Volatility
Traders will employ this strategy most often during times of high volatility. Bull call spreads benefit from two factors; a rising stock price and time decay of the short option.
Therefore, how do you build bull call spreads? A long call spread gives you the right to buy a stock at strike price A and the obligation to sell at strike price B if the contract is assigned.
Bull call spreads can be implemented by buying an at-the-money call option while simultaneously writing a higher striking out-of-the-money call option of the same underlying security and the same expiration month.
In other words, you buy one ATM call and sell 1 OTM call. In fact, our trading service goes in depth into options trading.
Building Bull Call Spreads
In order to create a bull call spread, you use two call options; the first with a lower strike price (A). The second with an upper strike price (B). Here’s a handy tip; you’ll want to pick an asset you think will go up in value over the next few days, weeks or months.
Here’s How It Looks:
- Buy one call option that has a strike price ABOVE the current market price with a specific expiration date based on your analysis. This is also known as a long call option. Pay the premium.
- Sell one call option with a higher strike price. This is known as a short call option. Ensure this call option has the same expiration date as the long call option in step 1. You will receive a premium as the seller of the call option.
Instead of just buying a long call option, you can build a bull call spread in order to minimize your risk or chance of losing money. I can’t emphasize how very important this is in the game of trading.
Selling a cheaper call with higher-strike B helps to offset the cost of the call you buy at strike A. A bullish call spread that reduces the cost of the option is the end result.
What’s more, it limits your risk since you can only lose the net cost to create the spread. So far so good.
However there is some bad news. To get the reduction in risk, you’re going to have to sacrifice some potential profits. As a result, the gains in the stock’s price are capped. In the event the stocks price skyrockets, you miss out on any potential gains; not so good.
What Happens to a Bull Call Spread at Expiration?
- The stock price falls below the price of the call option you purchased (A). Because of this, the investor chooses not to exercise the option. Therefore, it expires worthless. As a result, they lose the premium paid to purchase the option. If they exercise the option, they would have to pay more—the selected strike price—for an asset that’s currently trading for less. Which, in my opinion, doesn’t make fiscal sense.
- The stock price goes above the strike price of the call option you sold (B). Because of this, the investor exercises their first option as it has a lower strike price. Now, they can turn around and purchase the shares for less than the current market value.
A Real Life Example
For ease of understanding bull call spreads, let’s take American Airlines (AAL). Let’s say it’s currently trading at $42. However, you feel it’s going to increase due to news of a merger.
As a result, you decide to buy a $40 JUL call for $300 and write a $45 JUL call for $100. All in, the investment required for this spread is $200.
Sure enough, share prices of AAL start to increase and close at $46 on the expiration date. What this means is both options expire in-the-money.
Moreover, the $40 and $45 JUL calls have an intrinsic value of $600 and $100 respectively. In other words, the spread you entered into is now worth $500 at expiration. Once you subtract the cost to enter the trade ($200) from the total worth ($500), you’re left with $300.
On the other hand, if AAL share prices took a dive to $38 (no pun intended), both of your options expire worthless. You’ll lose the $200 it cost to enter into the spread. Which in fact, is also your maximum potential loss.
Break Even Point = Strike Price of Long Call + Net Premium Paid
Maximum Gains and Losses
There is a maximum profit with bull call spreads. Maximum gain is reached when the stock price moves above the higher strike price of the two calls. Your potential profit is equal to:
Strike Price A – Strike Price B – Net Premium Paid – Commissions
What’s the maximum loss incurred with bull call spreads? The great news here, your maximum loss cannot be more than the initial debit taken to enter the spread position.
In fact, this’ll occur when the price of the underlying security is less than the strike price of the long call. Our goal with trading is to cap loss. As a result, bull call spreads are popular for doing just that.
The Sweet Spot
You want the price of the stock to either be the same or above strike price B at expiration. However, you don’t want the strike so far above that you’re disappointed you didn’t simply buy a call on the underlying stock.
However, if this happens, look on the bright side. You played it smart and made a profit. And that’s always a good thing.
In fact, many times traders get in trouble trying to make too much money. How’s that possible? The stock market trades on the emotions of greed and fear.
When you allow greed to control your trading, many times you end up taking losses. You never go broke taking your profits. Even small ones.
Check out our trading room as we discuss trading with risk management.
What I Like About Bull Call Spreads
Bull call spreads are cheaper than buying an individual call option by itself. Therefore, you’re saving money and minimizing risk.
In fact, you don’t have to use a lot of capital to actually own the stock. As a result, a good way to grow a small account is trading spreads.
They limit the maximum loss of owning stock to the net cost of the strategy. In other words, your max loss is less with bull call spreads.
The Downsides
If the stock’s price goes above the strike of the call option that was sold on bull call spreads, you miss out on the gains. However, minimizing risk is more important than making huge gains every time.
In fact, making huge gains on every trade isn’t realistic. Slow and steady wins the race. As a result, it’s better to be safe than sorry.
The net cost of the premium paid limits gains. Therefore, bull call spreads are a great complement to riskier trading styles. In fact, you can trade any style with the right stock training.
Another downside to bull calls spreads is the risk of early assignment of the short stock option position.
Tip
Closing bull call spreads close to expiration gives you maximum value. If you choose to close your position prior to expiration, you’ll want as little time value as possible remaining on the call you sold.
You may wish to consider buying a shorter-term long call spread, e.g. 30-45 days from expiration. In fact, our yearly members have access to the best expiration’s when trading bull call spreads.
Wrapping It Up
If you’re a beginner or seasoned trader, trading options and bull call spreads are very powerful tools when traded correctly. It’s absolutely critical you develop a strategy before trading options.
Therefore, you don’t lose your hard earned money. We want to see you succeed.
If you need more help, take our options trading course.
