How To Use The Bull Call Spread To Reduce Risk And Increase Profitability

However, if the asset goes higher than your short call strike point, you have the option to buy the asset at the lower strike point , which is below current market value. In addition, since you are purchasing your long call option, your short call option is still active. You can then sell the contracts bought at that lower strike point at the price of your higher strike point , minus the premium, thus creating your capped profit. The maximum risk of the bullish call spread is limited to the total premium paid in buying a low strike price call. Simply put, it will be the total premium invested in buying the lower leg or lower strike price of this call spread strategy. The maximum risk is equal to the cost of the spread including commissions.

  • 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.
  • Selling or writing a call at a lower price offsets part of the cost of the purchased call.
  • Both calls have the same underlying stock and the same expiration date.
  • This method is simple but can be highly effective, especially when profit potential on the spreads is at least four times the risk.

In other words, there would always be enough profit from the purchased call to more than offset the losses on the sold call as the futures market price increases. To determine the maximum gain, start with the sold call option strike price, subtract the strike price of the call option purchased and the initial cost to implement the strategy. Also, subtract the commission costs ($12.20 – $9.70 – $1.43 – commission costs). Table 3 summarizes the results of the example bull call spread at varying futures settle prices. Call options can also be purchased as a strategy to retain ownership.

Generally speaking in a bull call spread there is always a ‘net debit’, hence the bull call spread is also called referred to as a ‘debit bull spread’. Given all this there is a high probability that the stock could stage a relief rally. However you are not completely bullish as whatever said and done the stock is still in a downtrend. The dotted yellow lines represent a long call option and a short call option. Factoring in net commissions, the investor would be left with a net loss of $7.

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Some of them can offer investors very efficient use of their capital. The bull call spread is a simple strategy that can be used by novice options traders to bet on higher prices. A covered call consists of a short call sold or written against a long stock position . A bull call functions similarly, with the long call taking the place of the actual shares. You can think of a bull call spread in a couple of different ways. For example, it’s fair to consider it as essentially a long call with some of the risk removed.

How To Construct A Bull Call Spread

A bull call spread is best used during times of high volatility. If you have an inkling that the price of a contract is going to rise moderately, and the market is exceptionally volatile, a bull call spread would be the trade to use. As we mentioned, you want to use this during times of volatility because it caps your max losses. While you may not be able to make as much money in the long run, the security of knowing how much you can potentially lose during a volatile market is a fair trade off.

bull call spread example

Once you have the contract, you need to structure the bull call spread. You do this by purchasing a call option above the current price of the asset with a set expiration date . Simultaneously, you will also sell a call option at a higher strike point thus creating a range. When you sell the call option at the higher strike point, this creates the premium which will help offset the call price you paid for the long call. A strategy consisting of the purchase of a call option with one expiration date and strike price and the simultaneous sale of another call with the same expiration date, but a different strike price. Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices.

Options Guy’s Tips

With the stock $45 points below the long 575 call at expiration, the long call spread expires worthless. The resulting loss for the call spread buyer is $2,145 ($21.45 debit paid x 100). If the stock price is in-between the strike prices at expiration, such as $149.81, the long 145 call will have value while the 155 call will expire worthless. At $149.81, the 145 call will be worth $4.81 ($149.81 Stock Price – $145 Strike Price) and the 155 call will be worth $0, resulting in no profit or loss on the trade. As we mentioned earlier, a bullish call spread is put in place by the use of two call options, however you may not know what a call option is. Call options for bull call spreads are another tool investors use to create an advantage in case of upward price movement.

bull call spread example

Investors often wrongly assume that because you take in premium and post margin with a credit spread, your position is always comparable to option writing. In fact, what really determines if a spread is like an option sale or purchase is whether the investor is selling or buying time premium on a net basis. Remember that at-the-money or close to-the-money options always have more time value than options that are further out-of-the-money or deeper in-the-money.

What Is A Bear Call Spread?

A bull call spread uses call options to profit from the price change of a stock about which you are bullish; you expect the stock to go up. This example demonstrates forex trading that a significant stock price increase results in healthy profits for a bull call spread trader. Unfortunately, the stock price ends up dropping just as quickly.

bull call spread example

As an example, let’s say you predict that the indicative underlying market will rise, so you’ve bought a Nadex Call Spread contract that expires at the end of the day. The bull call spread is a great play for traders who are moderately directional, but not outright convinced it will continue. For this reason, traders would use it on stocks where they have a slightly bullish view. In this case, the best way to avoid this risk is to simply close out the spread before expiry. One way to avoid assignment risk is to trade stocks that don’t pay dividends, or trade indexes that are European style and cannot be exercised early. This is particularly true will call options when traders will exercise their call option in order to receive an upcoming dividend.

FXCM Markets Limited (“FXCM Markets”) is incorporated in Bermuda as an operating subsidiary within the FXCM group of companies (collectively, the “FXCM Group” or “FXCM”). FXCM Markets is not required to hold any financial services license or authorization in Bermuda to offer its products and services. These two elements work together to provide unique trading opportunities where you have the time to be right. The market moves lower and when the contract expires, the US 500 indicative index is below the floor. You will lose the $31.00 you put up as collateral to secure the trade .

Call Spread Vs Put Spread: Definition, Types, And Key Differences

If you’re in need of a brokerage account for options trading, check out tastyworks, our preferred broker. You know how to determine the potential outcomes of a long call spread at expiration, Fiduciary but what about before expiration? To demonstrate how long call spreads perform before expiration, we’re going to look at a few examples of call spreads that recently traded in the market.

The Bull Call Spread

If the stock price remains below $50 and above $45, you can still break even with some profit. Spreads are combinations of different option positions on the same stock. Spreads are really not that complicated once you understand a few basic principals. The spreads that we will cover in this series will all have limited risk.

Bull Call Spread Options Strategy

Familiarity with the wide variety of forex trading strategies may help traders adapt and improve their success rates in ever-changing market conditions. He is a full member of the Society of Technical Analysts in the United Kingdom and combined with his over 20 years of financial markets experience provides resources of a high standard and quality. Russell analyses the financial markets from both a fundamental and technical view and emphasises what is a bull call spread prudent risk management and good reward-to-risk ratios when trading. Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

How To Manage A Bull Call Spread

The risk is most acute when a short option is in-the-money and has very little time value left. When the stock is below the lower call, theta hurts the trade as the more time passes the closer the trade gets to the maximum loss. Looking at the payoff diagram, we can see that above the higher strike price, both options are in-the-money and profit is both constant and positive due to the short call offsetting the long call. In this case, you suffer the maximum loss which is the $200 net debit you paid when you first executed the position. This means the strategy has limited risk as well as limited profit potential and is generally used when the market is in an upward trend.

RIGHTS OF REPRODUCTION AND DISTRIBUTION ARE RESERVED TO THE PUBLISHER. The Publisher does not give investment advice or act as an investment adviser. You have all heard “buy low, sell high if you are bullish.” This adage can help you remember how to structure your spreads. For a market that has been trending higher on the longer time frames, a pullback into a support level may provide an opportunity to get long the market before it resumes the trend higher. A market that has recently broken out to fresh highs on strong volume could potentially be a good candidate for a call spread. Such a market move could potentially allow the trader to capitalize on an extended upward move or resumption of an uptrend. And as a direct result, you now require a smaller upward movement in the underlying stock in order to break even or to make a profit.

Author: Chauncey Alcorn