This is the last part explanation of the 4 Vertical Spread options strategies where I will explain more in-depth about another vertical spread strategy for bullish play, which is the Bull CALL Spread Strategy. This is also known as CALL debit spread as the options buyer pays a premium (debit) in order to open up the spread position. The premium paid is also the maximum loss for the options contract buyer.
The 4 vertical spread strategies are summarised below:
A Bull CALL spread in an options strategy that consists of selling a CALL option with a higher strike price and buying a CALL with a lower strike price. Both CALL options have the same underlying stock and the same expiration date. A Bull CALL spread is established for a net debit and profits as the underlying stock increases in price.
In the previous article, I mentioned that a bullish strategy of using CALL Options is to buy CALL options and thus in this Bull CALL Spread, buying CALL is predominant, which will result in net debit incurred by the buyer when the contract is established. In order to have net debit, the premium paid is higher than the premium received.
Link to the previous article:
Vertical Spreads Options Strategies Explained For Newbies | A Simple Way To Understand And Remember Vertical Spreads
Using the inverse correlation between CALL options premium and strike price, i.e. higher strike price = lower premium and vice-versa, the buy CALL leg will be at a lower strike price (higher premium) than the sell CALL leg (lower premium), to fulfill the condition of debit paid up front.
As such, the buy CALL will happen at a lower SP while the sell CALL will happen at a higher SP, as summarized below:
I hope this helps in your understanding and remembering of the Bull CALL Spread strategy. This is a powerful strategy that you can use to long the market when the market is mooning or there is an obvious uptrend, while avoiding the higher premiums of buying CALL contracts.
What Is The Max Gain, Loss & Breakeven?
The maximum loss of a Bull CALL Spread is the premium that you pay when you open up the contract. This happens when both contracts expire OTM and become worthless.
The Maximum gain of a Bull CALL Spread is the difference of the strike price multiplied by 100 per contract, minus the premium you receive for the contract.
Max Gain = (Difference in SP x 100) – premium paid for contract
This is when both contracts expire ITM, thus you have to sell the shares at the higher price and buy the shares at the lower price.
The Breakeven Price is the higher SP – the premium price per share.
Bulll CALL Spread Example
An options trader buys 1 Bank of America (BAC) June 21 call at the $50 strike price and pays $2 per contract when Bank of America is trading at $49 per share.
At the same time, the trader sells 1 BAC June 21 call at the $60 strike price and receives $1 per contract. Because the trader paid $2 and received $1, the trader’s net cost to create the spread is $1.00 per contract or $100 in total premium paid. ($2 long call premium minus $1 short call profit = $1 multiplied by 100 contract size = $100 net cost plus, your broker’s commission fee)
If the stock falls below $50, both options expire worthlessly, and the trader loses the premium paid of $100 or the net cost of $1 per contract.
Should the stock increase to $61, both contracts expire in the money, which means the buyer will have to buy 100 BAC shares at $50 and sell 100 BAC shares at $60, which means he gains $1000 in total (or $10 per share) from this sale. However, since he already paid $1 per share or $100 in total for the contract when it was established, his net gain would be $1000 minus $100, which equate $900 or $9 per share.
To put it another way, if the stock fell to $30, the maximum loss would be only $1, but if the stock soared to $100, the maximum gain would be $9 for the strategy.
Advantages of a Bull CALL Spread
1. The benefit of a Bull CALL spread is that the trader reduces the cost of the trade. If the trader doesn’t expect the price of the asset to rise too much above the CALL option that was bought, this strategy is better than simply buying a CALL option.
2. A second advantage is that the breakeven price also rises. As a result of setting up a Bull CALL spread instead of only buying a CALL option, the trader reduces the dollar risk if the trade goes against them — and also increases their probability of profit.
Disadvantages of a Bull CALL Spread
1. The downside of a bull CALL spread is that there’s limited profit potential as compared to buying a CALL option. The potential is limited to the difference between the two strikes minus the premium paid. If a trader is expecting a powerful catalyst or strong financial earnings report, it’s preferable to simply buy a CALL option, as prices may rise far below any support levels.
2. Time decay (or Theta) works against the Bull CALL spread. This means a Bull CALL spread has a negative Theta (loses money with time decay). The longer the option contract drags without in the desired direction, the higher the drop in premium for the option buyer. Thus, the option buyer may suffer a loss even if the share price stays stagnant or has dropped slightly.
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