A bullish call spread involves buying a call option for a stock at or near its current price and selling a call option with a moderately higher strike price. This strategy limits risk and allows for potential profit if the stock price rises moderately. Maximum potential loss, breakeven point, and maximum profit can be anticipated.
A bullish call spread is an investment strategy that involves two call options on the same asset with the same expiration date. In this approach, an investor buys a call option to buy shares of a stock in the near future for a strike price at or near the current price of the underlying asset, and sells a call option with a strike price that is moderately higher than the current price. An investor uses a bullish buy spread when he believes that the price of a stock will rise in the near future, but only to a moderate degree. The bull call spread allows the investor to benefit from price growth, but also limits the risk of the investment. By using this strategy, an investor can anticipate his maximum potential loss, his break-even point, and his maximum profit.
For example, Warbucks Coffee is currently trading at $20 US Dollars (USD) per share. An investor, anticipating a rise in the Warbucks Coffee stock price over the next month, purchases a call option for 100 shares at a strike price of $20 USD expiring in one month for a payment of $300. USD. You also sell a call option for 100 shares at a strike price of $25 with expiration in one month for a premium of $100. Over the next month, Warbucks Coffee increases to $24 per share. The spread of the bull bet results in a profit of $200 for the investor, which is calculated by multiplying 100 shares by the $4 price increase minus the $300 payment for the first option plus the premium of $ 100 received for the second option.
The maximum potential loss with a call spread is the discrepancy between the premiums paid and received by the investor for the two call options. If the stock price does not rise as expected, the options are worth nothing at expiration, and the investor loses what he paid for the options. The breakeven point for a bullish bid spread is determined by dividing the costs by 100 and then adding the value obtained at the lower strike price. In the given example, the breakeven point occurs when the share price increased to $22 USD per share. With this strategy, the investor makes a profit if the stock price moves anywhere between $22 USD and $25 USD.
If the stock price rises above $25 per share, then the bullish spread limits the potential for profit. The second call option, while limiting downside risk, also limits maximum gain. If the price increases to $30 per share, the investor earns $10 per share on the first option and loses $5 per share on the second option. While he would still make a $300 profit on the deal, he has lost $500 by holding the second call option. For this reason, the bull call spread only makes sense when the expected market rise is modest with the upper bound of that rise somewhat predictable.
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