Bull Call Spread

Bull Call Spread

Bullish spreads with options can be created in a variety of different ways with either puts or calls. The most basic is a bull call spread, which is an example of a vertical spread because it uses options in the same expiration month but different strike prices, which are typically listed vertically on an options chain.  Like when buying straight calls, the investor is taking a bullish position in options on the underlying underlying stock, futures, ETF, etc. .

In a bull call spread, the strategist is also selling a higher strike call. Writing the higher strike call reduces the cost of the trade and will hedge some of the risk associated with time decay. There is a trade-off. If the underlying moves beyond the higher strike call, there is limited upside because the investor is short the contract. If the higher strike call option is in-the-money at expiration, assignment comes into play and the position has reached its max profitability. The best gain from a call spread is the difference between the two strikes minus the debit paid.

If, for example, Facebook (FB) is trading around $20 per share and we expect a rally to more than $30 by mid-2013, we might buy a June 25 – 30 call spread on the stock for 50 cents. In this strategy, we buy June 25 calls for $1.50 and sell June 30 calls at $1 per contract. Since the multiplier is 100 for an equity options position is 100, we pay $50 per spread. On 10 spreads, the total debit paid is $500. The debit is at risk if the position is left open through the expiration and FB holds below $25. At that point, both calls expire worthless. The breakeven at expiration is equal to the lower strike plus the debit, or at $25.50. At that point, the $25 call is worth 50 cents, which covers the cost of the trade. The 30s expire worthless. The potential payout is the spread minus the debit, or $4.50, if the stock rallies to more than $30. At that point, the options can be exercised/assigned at expiration – calling the stock at $25 and then having it called away for $30. Of course, the spread can also be closed out (all or partially) at any time prior to the expiration.

BULL CALL SPREAD EXAMPLE: BUY 10 FB Jun 25 – 30 Call Spreads @ 50 cents

Bias = Bullish, with limited upside beyond the higher strike call

Maximum Risk = Limited to the net debit paid = (Lower strike premium – higher strike premium): .50

Maximum Profit = Limited.  [(Difference in strikes – net debit) x 100]: 30 – 25 – .50

Breakeven = Lower call strike + net debit = 25 + .5 = 25.5