Bull Call Spread Option Strategies

Bull Call Spread Option Strategies


Hey everyone, and welcome back to Option Alpha.
This is Kirk, here again. And we’re talking about the option strategy bull call spread
here. So, we’ll get right into it here as always, taking a look at the market outlook
for this type of a strategy, when you would really place this type of a strategy as far
as your trading arsenal. So, the bull call spread strategy is really
going to be employed and used in the market when you see some moderate increases in the
underlying stock. So, not a huge breakout in the underlying stock, we’re not talking
about a 10% to 15% move, we’re talking about maybe a 2%, 3%, 5% move in the underlying
stock higher. So again, we are talking about a bull call option, so it’s going to be a
bullish strategy overall. You want the market to increase. But what’s really different about this type
of a spread is that you are not really, really that excited about the stock. You don’t think
it’s going to go higher, so you’re actually going to substitute one of your upside potentials
(being the long call) by selling an out-of-the-money call as well. So, this is where we get this
strategy that has two different options that are involved in it, and we’ll talk about this
later in the video. But you’re going to sell some of the upside potential and give up some
of that upside potential for the opportunity to get back some of your premiums. So, it’s
going to be a little bit cheaper strategy overall, but you’re going to give up again,
some of that upside potential. When we talk about how to set up this type
of a strategy, a bull call spread is really set up by buying one in-the-money call, and
then selling one out-of-the-money call on the same security on the same month. So again,
if we look at our chart here, we’re going to buy one in-the-money call, and let’s say
we’re going to buy for example, this $40 strike. So, that’s where our first call option is
going to pivot here on this graph. And then at the same time, we’re going to simultaneously
sell one call option at a strike price of $45. So, that’s how we have two of these kind of
pivots or directional movements in the profit loss diagram here. And that’s how you really
build this bull call spread. Just two simple options: You’re going to buy an in-the-money
call, and then sell an out-of-the-money call right around the market underlying price. So, what’s the risk for this type of a strategy?
Well, it’s pretty simple. The max loss is limited to the debit, so you’re actually going
to outlay some money for this call. And then, when you go and you sell the out-of-the-money
call, it’s going to be a little bit cheaper and you’re going to still incur a debit or
it’s going to cost you money to get into this trade. You’re actually buying the overall
spread. You’re not getting a credit. So, your max loss is limited to just that
debit. If the market were to absolutely crash after you initiated this trade, well, then
you would only lose your initial investment, and let’s say that’s $200 overall. So again,
the worst that can happen is that the stock can close below the lower strike at expiration.
In which case, both of these options would expire completely worthless, and you’d simply
be left with your debit as your max loss. So again, a very limited risk type of a strategy,
which is why people like it. So, let’s talk about profit potential now.
Again, as the same thing that we have limited risk on the downside, we’re also giving up
some of that unlimited profit potential on the top side. So, this position in this strategy
does have a capped game. It’s limited to a certain amount of gain in the underlying security.
So, if the stock closes at or above the short call strike, which in this case is 45, then
you can capture that maximum difference in premium and pricing. And anything above 45,
you’d still capture the same amount of money. So again, this is different than a call option
where we start to really start to see incremental gains in our underlying value. Anything above
45 where that short strike is on that call, you’re going to be capped, as far as how much
you’re going to earn. And then obviously, anything between the strike prices, so anything
closing between 40 and 45 is going to be resulting in a variable gain or loss, depending on where
you end at expiration. Volatility risk for these positions is actually
fairly low. There’s a little bit of volatility risk, just because you do have different option
strikes, so you’re going to have different types of reactions to volatility. But since
you’re long a call and short a call, the effects are really going to offset each other to a
really large degree. Time decay is going to be virtually the same
thing for this type of position as well. Since you’re long a call and short a call, the effects
of time decay on your long call are going to be completely offset by the positive effects
of time decay on your short call. So again, as we get closer to expiration now, this deadline
for achieving a profit is going to result in you having to make a decision. Since this
is a debit position and you did outlay money for it, you’re going to have to see a profit
or else, that profit is going to dwindle away at expiration. So, there is a little bit of
time decay risk, but it’s not a great time decay risk. You can still make a trade. The
market can move around or move sideways and then move later on. And you’re not going to
have a real big risk of making a quick decision on this type of a trade. So, breakeven points: This is important to
calculate with these bull call spreads. The strategy breaks even in expiration if the
stock price is above the lower strike by the initial amount of the debit. So again, if
we traded the initial strike price of long call at $40 and we outlaid $200, then we would
want to see the stock at least go up $2, so that we can capture our premium. You can see
that this is where our profit loss diagram crosses over here on this chart. It’s right
at 42 which is the $40 strike, plus our cost or our debit, to enter the position of $200.
And so, that’s going to equate to about a $42 strike price on the chart. So again, it’s the long call strike, plus
the net debit that we received. That’s going to be our breakeven point. So, as you’re starting
to look at charts, and if you enter this position and calculate your breakeven, you’re going
to want to see. Is it really possible for the stock to make that type of a move, or
is there some resistance that could be impeding that type of a move on a stock chart? So,
if you start to see that your breakeven point is much higher than you thought before, and
you think it can definitely get above 40, but maybe not above 42, then you might want
to reconsider entering the strategy of course. So, some of my tips and tricks for the bull
call spread: Obviously, the more out of the money your strike prices are, the more bullish
you’re going to be. You don’t necessarily have to enter the first strike in the money.
You can enter the first strike out of the money. So again, using this chart is our example.
Let’s say that the market is actually trading at 35 right now. Your first strike could be
a 40 strike, which is actually out of the money to begin with. Now, these cheaper debits doesn’t necessarily
mean that you have a better position. Just because the price is cheaper doesn’t necessarily
mean that you’re going to make more money or that it’s an easier position. The price
being cheaper means that it’s less likely that it could move higher, and you will be
compensated if it does. So, you’re taking on more risk. Cheapness and option strategies
does not necessarily mean better. Now, if you’re having trouble filling these
positions, try legging into the spread. I know a lot of people who try to fill with
these positions, and it’s really tough because you do have to enter both sides of the spread
exactly at the same time in the market. So, why not try to buy or sell just one single
leg of the option spread, and then come back in later and reenter the other one? So, for example: you would buy the 40 strike
call first, let that order get executed, and then come back in later and resell the 45
strike call. Again, completing your spread at the end of the day, but it’s a lot better
way to get into the market at better prices. And legging in is always a good option if
you can’t get fills. Hey, thanks for watching this video from Option
Alpha. As always, we invite you guys to come back and check us out at optionalpha.com.
And if you like this video, please share the video with any of your friends, family, or
colleagues on your favorite social network.

7 thoughts on “Bull Call Spread Option Strategies

  1. Ok what happens if the buyer of that call option you sold desides to exercrise that option . Dont u lose out more then what u invested ??

  2. Hi Kirk! Thanks for the video! Can you please provide insight as to how you would select the strike prices on each side of the trade and expiration date for this type of trade?

    Last of all, how does time affect this trade? For example, how is profit amount affected by the amount of time to expiration? 

  3. Currently, Amazon has a low implied volatility and to it is looking moderately bullish. I want to buy the call spread so I will be on the right side of volatility, but won't time decay hurt me? Will it hurt me more or less?

Leave a Reply

Your email address will not be published. Required fields are marked *