Options Trading Strategy - Bull call spread
What is Bull Call Spread Options Trading strategy?
A Bull call spread option trading strategy involves two call options with different strike price but same expiration date. Bull call spread is also considered as a cheaper alternative to long call, because it involves selling of call option to offset some of the cost of buying calls.
When to initiate a Bull Call spread?
Bull call spread options trading strategy is used when the option trader thinks that the underlying assets will rise moderately in the near term. This options trading strategy is basically used to reduce the upfront costs of premium, so that less investment is required and it can also reduce the effect of time decay.
How to Construct the Bull call spread?
Buy 1 ITM/ATM Call
Sell 1 OTM Call
Bull call spread is implemented by buying in-the-money or at-the-money call option and simultaneously selling out-the-money call option of the same underlying security with the same expiry.
| Strategy | Buy ITM/ATM Call+ Sell OTM Call |
|---|---|
| Market Outlook | Moderately Bullish |
| Breakeven at expiry | Strike price of buy call + Net Premium Paid |
| Risk | Limited to Net premium paid |
| Reward | Limited |
| Margin required | Yes |
Let’s try to understand with an Example:
| ABC LTD Current market Price | 8150 |
|---|---|
| Buy ITM Call (Strike Price) | 8100 |
| Premium Paid (per share) | 60 |
| Sell OTM Call (Strike Price) | 8300 |
| Premium Received | 20 |
| Net Premium Paid | 40 |
| BEP (Rs.) | 8140 |
| Lot Size | 75 |
Suppose the stock of ABC Ltd is trading at Rs. 8150. If you believe that price will rise to 8300 or before the expiry, then you can buy in-the-money call option contract with a strike price of Rs. 8100, which is trading at Rs. 60 and simultaneously sell out-the-money call option contract with a strike price of 8300, which is trading at Rs. 20. You paid Rs. 60 per share to purchase single call and simultaneously received Rs. 20 by selling 8300 strike price. So, the overall net premium paid by you would be Rs. 40.
So, as expected, if ABC Ltd rallies to Rs. 8,300 on or before option expiration date, then you can square off your position in the open market for Rs. 160 by exiting from both legs of the trade. As each option contract covers 75 shares, the total amount you will receive is Rs. 12,000. Since you had paid Rs. 3000 to purchase the call option, your net profit for the entire trade is, therefore Rs. 9,000. For the ease of understanding, we did not take in to account commission charges.
The Payoff Schedule
| On Expiry ABC LTD closes at | Net Payoff from Call Buy (Rs.) | Net Payoff from Call Sold (Rs.) | Net Payoff (Rs.) |
|---|---|---|---|
| 7600 | -60 | 20 | -40 |
| 7700 | -60 | 20 | -40 |
| 7800 | -60 | 20 | -40 |
| 7900 | -60 | 20 | -40 |
| 8000 | -60 | 20 | -40 |
| 8100 | -60 | 20 | -40 |
| 8140 | -20 | 20 | 0 |
| 8200 | 40 | 20 | 60 |
| 8300 | 140 | 20 | 160 |
| 8400 | 240 | -80 | 160 |
| 8500 | 340 | -180 | 160 |
| 8600 | 440 | -280 | 160 |
| 8700 | 540 | -380 | 160 |
Bull call spread’s payoff chart:
Analysis of Bull call spread Options Trading strategy
The Bull call spread options trading strategy is best to use when investor is moderately bullish because investor will make maximum profit only when stock price rises to the higher (sold) strike. Although your profits will be limited if the price does not rise higher than you expected.
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