For investors certain that a stock will rise somewhat in price, the bull call spread definition is an options strategy that may be used. An ITM call option is bought and sold with an OTM call option with a higher strike price but the same underlying stock and expiry date as an ITM call option. It is only prudent to employ a bull call spread if the market shows signs of an upward trend.

Bull Call Spread

Over a certain time, choose the item you anticipate will appreciate somewhat in value. You may pay the premium to buy a margin call with a strike price just above the current market and an expiry date.

As an alternative, sell a higher-strike call option with the same term as the original call option, then collect the premium.

The investor receives a portion of the price he paid for the call option when he sells the option. The distinction between the 2 call options represents the program’s cost for investors to take on debt.

The bull call spread lowers the cost of a call option, but at a cost. The stock’s price rises are likewise capped, limiting the investor’s profit potential. This spread is used by traders who anticipate an asset’s value is likely to grow in the medium term. During periods of extreme volatility, they are more likely to choose this method.

Due to the lower and higher strike prices, the bull call spread’s losses and profits are restricted. As a rule of thumb, investors do not execute options when stock prices fall below their lower strike price. Investing in an option strategy is a losing proposition when it expires worthless. If they decide to exercise this right, they will be forced to pay a higher price for an asset now selling at a lower price.

First, if the stock price rises over the higher strike price of the second, sold call option, the investor exercises their 1st option with the lesser strike price at the expiration time. They can now buy the shares at a lower price than the market value.

However, the option to sell a call is still available to investors. You may be certain that the options market will take care of this call option for you. For the second strike option, the investor would sell the shares they purchased at the lower first strike option price.

When you purchase a first-call option, your profit is limited to the strike price of an option you sold. If the lower strike price is below the higher strike price, the profit is the distinction between the two prices less the net cost or price paid at the outset.

Bull Call Spread Formulas With Examples

Bull call spread: Options traders buy a JUL 40 option for $300 and sell a JUL 45 option for $100 based on the belief that XYZ stock selling at $42 is likely to rise shortly. To put just on the spread, you’ll have to deduct $200 from your bank account.

XYZ’s stock rises steadily until it reaches $46 on the expiry date. Options expiring in the money have an inherent value of $600 for a JUL 40 call and $100 for a JUL 45 call, respectively. As a result, the spread will be worth $500 when it expires. Because of the trader’s initial debt of $200, he has a net profit of $300.

It would have been useless if the cost of XYZ had dropped to $38 instead. In this case, the trader’s $200 investment will be wiped out, which is the maximum loss.

The bull call spread may be used with stock options, ETF options, index options, futures options, and futures contracts. Let’s check out the bull call spread strategy example

Example –

Using a bull call spread meaning, Jorge hopes to profit from ABC Company. One hundred and fifty dollars for the ABC Company is now the market price. Ten dollars is the cost for an “in the money” choice. In January 2020, the option’s strike price was $145, and it expires at that time.

For an additional $2, Jorge sells a call option on a stock that is not currently in the money. The option has a $180 strike price and a January 2020 expiration date. Are there any limits on how much money the bull call spread can make and how much it may lose?

The net profit is $8 ($2 on the OTM call and $10 on the ITM call).

Using the bull call spread calculator, Jorge calculates:

• $180 minus $145 minus $8 equals $27 as the maximum profit possible.
• The maximum amount of money that may be lost is $8.
• It costs $145 + $8 = $153 to break even.

How Is A Bull Call Spread Implemented?

To use a bull call spread, you need to choose an asset with a long enough time horizon that it is expected to appreciate somewhat (days, weeks, or months). The next stage is buying a call option with a strike price just above the current market and an expiry date.

Also Read: Bull Market versus Bear Market

The next step is to sell a call option with a higher strike price and an expiration date identical to the first call option. Selling the call for more money than you paid is the strategy’s true cost since you are making a profit on both sides of the trade.

How Does It Work?

Using a bull call spread strategy may assist traders in reducing the risk of suffering large losses if they bet in the wrong direction since the maximum losses are restricted to the net amount of premiums spent and recovered. Because of the short call sale, the long call’s premium is reduced, but the profit is limited to the market price of the short call, which limits potential profits.

When traders try to keep premium costs down, they cannot increase their profit margins by limiting the strike price discrepancies. On the other hand, traders that are more daring may construct calls with a wider spread between their strike prices to enhance their profit margins even more.

Traders who use bull call spread risk losing all their premiums if the investment fails to grow in value well before the expiry date. They are also not a good technique for traders who want to make a lot of money. Traders cannot benefit from an asset’s quick appreciation since the short call places an upper limit on profits.

Also Read: Bullish and Bearish Market Trend in India

In cases when call options are costly and returns are projected to be modest, spreads are a better alternative since the premiums on short and long calls of spread will assist balance the capital outlay. In the end, assessing the market’s mood before committing this spread type is critical since it works best in particular circumstances.

Signs of Profit and Loss

It is possible to benefit from this spread in two ways. First, if the fundamental security’s price rises, your options investments will be profitable. Secondly, time decay will help you make money from your out-of-cash choices. This is the best-case scenario: the underlying security’s price rises to around the market price of the issued options contracts.

Because underlying securities prices rise over that threshold, written contracts will become insolvent if they are not canceled. You will not pay anything, but the value of the bee caus options you possess will rise simultaneously.

The spread will lose money if the underlying asset does not rise in price. Even though you stand to gain from your short position, the options you possess will lose all their value when the contracts they represent expire worthless. However, your losses are restricted since you can only lose the amount you paid to put the spread on in the first place.

Advantages

With the bull call spread, you may lower the cost of initiating a long call position by entering a short call option at the same time. Your profit margins will be reduced as a result, but your profit margins may still be managed by adjusting the fixed rate of contracts you write to reflect the current market conditions.

A higher return on the investment is possible, as well as lower losses if the stock’s value declines. This is a benefit above merely purchasing call options. To put it another way, this is a basic approach that many traders find appealing since it gives them an idea of how much they lose when they place the spread on.

Disadvantages

The spread has various drawbacks that should be taken into account. One of the greeks, “theta,” is one of the major drawbacks of such a bull call spread because of temporal decay.

Because choices have an expiry date, their value decreases with time, regardless of the other inputs. To put it another way, you need to be accurate about both the direction of the market and the time of entry.

Depending on the size of the market move, bull call spreads can potentially be profitable. As a result, the bull call spread strategy should only be used when a significant move is foreseen.

Possible Adjustments

Adjustments may be made to a bull call spread at any time. If the market moves in your favor, you can consider buying back the spread’s short leg. However, despite this, the entire risk of the deal is still well specified. A short position may become an endless profit opportunity by buying back the short leg.

There are additional options for spreads that are not working according to plan. One way to do this is to sell the spread back into the business and then buy it again later.

The bull call spread is a low-risk, high-potential strategy that even newcomers may take advantage of. Using the spread may provide substantial profits with little effort. The bull call spread is an essential aspect of every trader’s toolbox because of its multiple benefits.

Conclusion

Here, you can see how a basic strategy like the bull call spread at Nuuu may provide many benefits with just a few risks. With an optimistic view and an ability to accurately forecast the market value of the underlying security, this is a great technique to adopt.

For bull call spread example, even while the underlying value may rise beyond your expectations, the reduced expenses at the outset will boost your return on the investment and further minimize your losses.

If you’re still considering taking the plunge into investing, get things rolling by opening a Demat account with Nuuu