A bull call spread, also known as a long call spread or a vertical spread, is an options trading strategy used to capitalize on moderate price increases for a stock. The strategy has two legs and involves writing one option and buying another.
Investors use a bull call spread when they’d like to take advantage of a slightly bullish trend in a stock without taking too much risk. This type of options trading strategy limits both profits and losses, making it a popular strategy for investors with limited capital and a desire for downside protection.
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What Is a Bull Call Spread Position?
To initiate a bull call spread, options traders buy a call option at a lower strike price while selling a call with a higher strike price. Both options have the same expiration date and underlying asset.
This options strategy establishes a net debit or cost and makes money when the underlying stock rises in price. The potential profits hit a limit when the stock price rallies higher than the strike price of the short call, while potential losses hit a limit if the stock price declines beneath the strike price of the long call (the one with a lower strike price).
In a bull call spread, a trader cannot lose more than the net premium plus commissions. A trader’s maximum gain is the difference between the strike prices of the short and long call and net premium plus commissions.
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Bull Call Spread Example
Let’s say a trader establishes a bull call spread by purchasing a call option for a premium of $10. The call option has a strike price of $50 and expires in April 2022. The trader also sells (or writes) a call option for a premium of $2. The call option has a strike price of $70 and expires in April 2022. The underlying asset of both options is the same and currently trades at $50.
In establishing these options positions, the trader paid $10 (from buying the long call) and gained $2 (from writing the short call). The net amount of these two contracts adds up to a net cost of $8.
Assume that the expiration date of April 2022 has arrived.
With a stock price of $60 or above, the trader’s investment cannot gain more than $3 due to both calls being in-the-money. If the stock price were $65, for example, the investor would gain through the long call by being able to buy shares for $50 and sell at the market price of $65. They would also lose through the short call due, since they’d have to buy shares at the market price of $65 and sell to the option holder at a price of $60.
After net commissions, the trader would realize a net gain of $3.
At a price of $50 or less, the trader’s loss is limited to $7, since both calls would be out-of-the-money. At a stock price of $45, for example: the trader wouldn’t gain from the long call, and would not lose from the short call.
After net commissions, the trader would realize a net loss of $7.
Variables Impacting a Bull Call Spread
As with any options trading strategy, various potential factors can have an effect on how the trade will play out. The ideal market forecast for a bull call spread is “modestly bullish,” or that the underlying asset’s price will gradually increase.
As with all options, the price of the underlying security is only one of several factors that can impact the trade.
Stock Price Change
A bull call spread will increase in value as its underlying stock price rises and decline in value as the stock price falls. This kind of position is referred to as having a “net positive delta.”
Delta estimates how much the price of an option could change as the underlying security price changes. The change in option price is usually less than that of the stock price – the stock price could fall by $1, but the option may only fall by $0.50, for example.
Because a bull call spread contains one short call and one long call, the net delta doesn’t change much when the stock price changes on any given day. In options vocabulary, this is called “near-zero gamma.” Gamma provides an estimation of how much the delta of a position could change when the stock price changes.
Change in Volatility
Volatility refers to how much a stock price fluctuates in percentage terms. Implied volatility (IV) is a factor in options pricing. When volatility rises, opti prices often rise if other factors remain unchanged.
Because a bull call spread consists of one short call and one long call, the price of this position changes little when volatility changes (an exception may be when higher strike prices carry higher volatility). In options vocabulary, this is called having a “near-zero vega.” Vega is an estimation of how much an option price could change with a change in volatility when other factors remain constant.
Time is another important variable that influences the price of an option. As expiration approaches, an option’s total value decreases, a process called time decay.
The sensitivity to time decay in a bull call spread depends on where the stock price is in relation to the strike prices of the spread. If the stock price is near or below the price of the long call (lower strike), then the price of the bull call spread declines (and loses money) as time goes on. This occurs because the long call is closer to the money and loses value faster than the short call.
On the other hand, if the price of the underlying stock is near or above the strike price of the short call (higher strike), then the price of a bull call spread rises (and makes money) as time goes on. This occurs because the short call has become closer to the money in this situation and therefore loses value quicker than the long call.
In the event that the stock price is half-way between both strike prices, time decay will have little impact on the price of a bull call spread. In this scenario, both call options decay at more or less the same rate.
Risk of Early Assignment
Traders holding American-style options can exercise them on any trading day up to the day of expiry. Those who hold short stock options have no control over when they may have to fulfill the obligation of the contract.
The long call in a bull call spread doesn’t have early assignment risk, but the short call does. Calls that are in-the-money and have less time value than the dividends that a stock pays are likely to be assigned early.
This can happen because when the dividend payout is greater than the price of the option, traders would rather hold the stock and receive the dividend. For this reason, early assignment of call options usually happens the day before the ex-dividend date of the underlying stock (the day by which investors must hold the stock in order to receive the dividend payout).
When the stock price of a bull call spread is above the strike price of the short call (the call with a higher strike price), traders must determine the likelihood that their option could be assigned early. If it looks like early assignment is likely, and a short stock position is not desirable, then a trader must take action.
There are two ways to do away with the risk of early assignment. Traders can either:
• Close the entire spread by buying the short call to close and selling the long call to close, or
• Buy to close the short call and leave the long call open.
Pros and Cons of Using a Bull Call Spread
The main advantages of using a bull call spread is that it costs less than buying a single call option and limits potential losses. In the earlier example, the trader would have had to pay a $10 premium if she had only been using one call option. With a bull call spread, she only has to pay a net of $8.
The potential losses are lower as well. If the stock were to fall to zero, our trader would realize a loss of just $8 rather than $10 (if she were using only the long call option).
The biggest drawback of using a bull call spread is that it limits potential gains as well. In the example above, our trader can only realize a maximum gain of $27 because of the short call option position. In the event that the stock price were to soar to $400 or higher, she would still only realize a $27 profit.
A bull call spread is a two-leg options trading strategy that involves buying a long call and writing a short call. Traders use this strategy to try and capitalize on moderately bullish price momentum while capping both losses and gains.
As with all trades involving options, there are many variables to consider that can alter how the trade plays out. Of course you don’t have to invest in options to build a portfolio. A great way to get started is via the SoFi Invest stock trading platform. The website and app make it accessible to trade your stocks, ETFs, and cryptocurrency.
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