Bull Call Spread
Description
Establishing a bull call spread involves the purchase of a call option
on a particular underlying stock, while simultaneously writing a call
option on the same underlying stock with the same expiration month,
at a higher strike price. Both the buy and the sell sides of this
spread are opening transactions, and are always the same number of
contracts. This spread is sometimes more broadly categorized as
a "vertical spread": a family of spreads involving options of
the same stock, same expiration month, but different strike prices.
They can be created with either all calls or all puts, and be
bullish or bearish. The bull call spread, as any spread, can
be executed as a"unit" in one single transaction, not as
separate buy and sell transactions. For this bullish
vertical spread, a bid and offer for the whole package can be
requested through your brokerage firm from an exchange
where the options are listed and traded.
P/L Profile
Market Opinion
Moderately Bullish to Bullish
When to Use
Moderately Bullish
An investor often employs the bull call spread in moderately
bullish market environments, and wants to capitalize on a modest
advance in price of the underlying stock. If the investor's
opinion is very bullish on a stock it will generally prove
more profitable to make a simple call purchase.
Risk Reduction
An investor will also turn to this spread when there is
discomfort with either the cost of purchasing and holding
the long call alone, or with the conviction of his bullish
market opinion.
Benefit
The bull call spread can be considered a doubly hedged strategy.
The price paid for the call with the lower strike price is
partially offset by the premium received from writing the
call with a higher strike price. Thus, the investor's
investment in the long call, and the risk of losing the
entire premium paid for it, is reduced or hedged.
On the other hand, the long call with the lower strike price
caps or hedges the financial risk of the written call with the
higher strike price. If the investor is assigned an exercise
notice on the written call and must sell an equivalent number
of underlying shares at the strike price, those shares can be
purchased at a predetermined price by exercising the purchased
call with the lower strike price. As a trade-off for the hedge
it offers, this written call limits the potential maximum profit
for the strategy.
Risk vs. Reward
Upside Maximum Profit: Limited
Difference Between Strike Prices - Net Debit Paid
Maximum Loss: Limited
Net Debit Paid
A bull call spread tends to be profitable when the underlying stock
increases in price. It can be established in one transaction, but
always at a debit (net cash outflow). The call with the lower strike
price will always be purchased at a price greater than the offsetting
premium received from writing the call with the higher strike price.
Maximum loss for this spread will generally occur as the underlying
stock price declines below the lower strike price. If both options
expire out-of-the-money with no value, the entire net debit paid
for the spread will be lost.
The maximum profit for this spread will generally occur as the
underlying stock price rises above the higher strike price, and
both options expire in-the-money. The investor can exercise the long
call, buy stock at its lower strike price, and sell that stock at
the written call's higher strike price if assigned an exercise
notice. This will be the case no matter how high the underlying
stock has risen in price. If the underlying stock price is in
between the strike prices when the calls expire, the long call
will be in-the-money and worth its intrinsic value. The written
call will be out-of-the-money, and have no value.
Break-Even-Point (BEP)
BEP: Strike Price of Purchased Call + Net Debit Paid
Volatility
If Volatility Increases: Effect Varies
If Volatility Decreases: Effect Varies
The effect of an increase or decrease in the volatility of the
underlying stock may be noticed in the time value portion of
the options' premiums. The net effect on the strategy will
depend on whether the long and/or short options are in-the-money
or out-of-the-money, and the time remaining until expiration.
Time Decay
Passage of Time: Effect Varies
The effect of time decay on this strategy varies with the underlying
stock's price level in relation to the strike prices of the long and
short options. If the stock price is midway between the strike prices,
the effect can be minimal. If the stock price is closer to the lower
strike price of the long call, losses generally increase at a faster
rate as time passes. Alternatively, if the underlying stock price is
closer to the higher strike price of the written call, profits
generally increase at a faster rate as time passes.
Alternatives before expiration
A bull call spread purchased as a unit for a net debit in one
transaction can be sold as a unit in one transaction in the options
marketplace for a credit, if it has value. This is generally the
manner in which investors close out a spread before its options
expire, in order to cut a loss or realize profit.
Alternatives at expiration
If both options have value, investors will generally close out a
spread in the marketplace as the options expire. This will be less
expensive than incurring the commissions and transaction costs
from a transfer of stock resulting from either an exercise of
and/or an assignment on the calls. If only the purchased call
is in-the-money as it expires, the investor can either sell
it in the marketplace if it has value or exercise the call
and purchase an equivalent number of shares. In either of
these cases, the transaction(s) must occur before the close
of the market on the options' last trading day.
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