Bull Call Spread Options Trading Strategy: Definition, How to Trade it

A bull call spread is a bullish options strategy constructed by buying a call option with a lower strike price (closer to at-the-money) and simultaneously selling a call option with a higher strike price. This spread is initiated for a net debit, as the premium paid for the lower strike call will be greater than the premium received for selling the higher strike call. 

From that perspective, this spread may also be referred to as a "long call spread." This strategy aims to profit from a bullish market outlook, with both limited risk and limited profit potential. 

The bull call spread is technically a form of vertical spread. Vertical spreads are options strategies that involve opening long (buying) and short (selling) positions simultaneously, with the same underlying asset and expiration, but with different strike prices. With a vertical spread, both of the options must be of the same type - both puts or both calls. 

There are four types of vertical spreads, and the bull call spread is one of them. The other three vertical spreads are the bull put spread, the bear call spread, and the bear put spread. These spreads are sometimes referred to as a short put vertical (bull put spread), a long put vertical (bear put spread), a short call vertical (bear call spread), and a long call vertical (bull call spread). 

A bull call spread is constructed by buying a call option with a lower strike price (closer to expiration) and simultaneously selling a call option with a higher strike price, with both options expiring on the same date.

This spread is initiated for a net debit, as the premium paid for the lower strike call will be greater than the premium received for selling the higher strike call. Similar to the bull put spread, the bull call spread offers a structured approach to capitalize on upward movement in the underlying asset. 

More details on the bull call spread are outlined below.

Basic Concept of Vertical Spreads

• Vertical spreads entail the simultaneous buying and selling of options of the same type (calls or puts) with identical expiration dates but differing strike prices. 

• These strategies are distinguished by their vertical arrangement on an options chain.

Structure of a Bull Call Spread

• In a bull call spread, the trader purchases a call option with a lower strike price and concurrently sells a call option with a higher strike price. 

• Both options have the same expiration date, resulting in a net debit for the position. 

Profit Potential

• The objective of a bull call spread is to profit from a bullish market outlook. 

• The maximum profit is realized if the price of the underlying asset exceeds the higher strike call option at expiration.

Maximum Gain

• The maximum gain for a bull call spread is the difference between the strike prices minus the net debit paid when initiating the trade. 

• This is achieved if the price of the underlying asset exceeds the higher strike price at expiration. 

Maximum Loss

• The maximum loss for a bull call spread is the net debit paid when initiating the trade. 

• This occurs if the price of the underlying asset remains below the lower strike call option at expiration.

Breakeven Point

• The breakeven point for a bull call spread is the strike price of the purchased call option plus the net debit paid. 

• The trade will be profitable as long as the price of the underlying asset exceeds this level at expiration.

In the following examples, imagine that an investor or trader is bullish on the underlying, and decides to deploy a bull call spread, because this trade structure tends to benefit from a bullish move in the underlying. 

The two examples outlined below help illustrate how the risk-reward profile of a bull call spread shifts when different strikes are selected for the spread. 

Example 1

Initial Position

• Stock XYZ is trading at $70 per share.

• The investor expects the price of XYZ to rise moderately. 

• The investor buys 1 call option with a strike price of $70 for a premium of $4 per share.

• The investor simultaneously sells 1 call option with a strike price of $75 for a premium of $2 per share.

• The net debit is equal to $4 - $2 = $2

Maximum Gain

• The maximum gain is the difference between the strike prices minus the net debit paid when initiating the trade. In this case, it is $75 - $70 - $2 = $3 per share.

• Since each contract represents 100 shares, the maximum gain per contract is $300.

Maximum Loss

• The maximum loss for a bull call spread is the net debit paid when initiating the trade. In this case, it is $4 - $2 = $2 per share.

• Since each contract represents 100 shares, the maximum loss per contract is $200.

Preferred Outcome

• The preferred outcome is for the price of XYZ to exceed $75 at expiration, in which case the maximum profit will be realized. 

Example 2

Initial Position

• Stock XYZ is trading at $70 per share.

• The investor expects the price of XYZ to rise moderately.

• The investor buys 1 call option with a strike price of $75 for a premium of $3 per share.

• Simultaneously, the investor sells 1 call option with a strike price of $80 for a premium of $1.50 per share.

• The net debit is equal to $3 - $1.50 = $1.50

Maximum Gain

• The maximum gain is the difference between the strike prices minus the net debit paid when initiating the trade. In this case, it is $80 - $75 - $1.50 = $3.50 per share.

• Since each contract represents 100 shares, the maximum gain per contract is $350.

Maximum Loss

• The maximum loss for a bull call spread is the net debit paid when initiating the trade. In this case, it is $3 - $1.50 = $1.50 per share.

• Since each contract represents 100 shares, the maximum loss per contract is $150.

Preferred Outcome

• The preferred outcome is for the price of XYZ to exceed $80 at expiration, in which case the maximum profit will be realized. 

As with any options-focused trading strategy, there are pros and cons associated with the bull call spread. Some of the advantages of the bull call spread are outlined below:

• Defined Risk: One of the primary advantages of the bull call spread is that it offers limited risk. As a result of its defined-risk nature, the maximum potential loss of a bull call spread is predefined and limited to the net debit paid when entering the trade.

• Defined Maximum Profit: Similar to the defined risk nature of this position, the maximum profit potential of a bull call spread is also predefined. Traders know the exact amount they can potentially gain from the trade, which is the difference between the strike prices minus the net debit paid when entering the position.

• Lower Cost Basis: Compared to buying a call option outright, a bull call spread typically requires less capital because the premium received from selling the higher strike call option helps offset the cost of purchasing the lower strike call option. This lower cost basis can make the strategy more accessible to traders with limited capital.

• Structural Flexibility: Traders can adjust the structure of the bull call spread by selecting different strike prices and expiration dates based on their outlook and risk tolerance. This flexibility allows for customization of the strategy to suit specific market expectations and trading objectives.

As with any options-focused trading strategy, there are pros and cons associated with the bull call spread. Some of the disadvantages of the bull call spread are outlined below:

• Limited Profit Potential: One of the main drawbacks of a bull call spread is that it caps the maximum potential profit. In strongly bullish scenarios where the underlying asset's price surges significantly, traders may miss out on potential profits beyond the spread's maximum gain.

• Cost of Entry: Although bull call spreads require less initial capital as compared to buying a call option outright, there is still a cost associated with entering the trade. Traders need to pay the net debit upfront to establish the spread, which can impact overall profitability, especially if the underlying price doesn't exceed the breakeven point.

• Breakeven Point: The breakeven point for a bull call spread is the strike price of the purchased call option plus the net debit paid. The underlying asset's price must therefore rise above this level before the trade starts becoming profitable. And if the underlying price fails to exceed the breakeven point by expiration, the position will produce a loss. 

• Impact of Time Decay: Although bull call spreads mitigate some effects of time decay, they don't mitigate all of the risk. As expiration approaches, the extrinsic value of the options will decline, potentially reducing the spread's value. Traders need to consider the impact of time decay when managing their positions, and timing their entry and exit points. 

The preferred outcome for a bull call spread is for the price of the underlying asset to rise above the higher strike call option (the short call) at expiration. In this scenario, both options expire in-the-money, and the difference between the strike prices (less the net debit) represents the maximum gain.

On the other hand, if the price of the underlying asset remains below the lower strike call option at expiration, the position will incur the maximum loss, which is limited to the net debit paid when entering the trade.

The maximum profit and maximum loss are summarized below.

Maximum Profit

• The maximum profit for a bull call spread is achieved if the price of the underlying asset rises above the higher strike call option at expiration.

• The maximum profit is equal to the difference between the strike prices minus the net debit paid when entering the trade.

• In this scenario, both options expire in-the-money.

• Formula: Maximum Profit = Difference in Strike Prices - Net Debit Paid

Maximum Loss

• The maximum loss for a bull call spread is incurred if the price of the underlying asset remains below the lower strike call option at expiration.

• The maximum loss is capped at the net debit paid when entering the trade.

• Formula: Maximum Loss = Net Debit Paid

Both a bull call spread and a bull put spread are a type of vertical spread. The primary differences between a bull call spread and a bull put spread lie in the types of options used and the expected magnitude of movement in the underlying. 

A bull call spread involves buying a call option with a lower strike price and simultaneously selling a call option with a higher strike price, with the expectation of benefiting from a bullish market outlook. Conversely, with a bull put spread, the trader sells a put option with a higher strike price and buys a put option with a lower strike price, aiming to profit from a moderately bullish, or neutral market outlook.

While both strategies offer limited risk and limited profit potential, the preferred outcomes differ. For a bull put spread, the ideal scenario is for the underlying asset to remain above the higher strike put option at expiration, resulting in the maximum profit. In contrast, for a bull call spread, the desired outcome is for the underlying asset to rise above the higher strike call option at expiration, which also results in the maximum profit. 

In short, the bull put spread benefits from slightly bullish movement in the underlying (or even sideways movement), while the bull call spread tends to benefit from a more significant upside move in the underlying. Ultimately, the choice between these strategies depends on factors such as market conditions, risk tolerance, and the trader's outlook on the underlying asset.

A bull call spread is a bullish options strategy constructed by buying a call option with a lower strike price and simultaneously selling a call option with a higher strike price. This spread is initiated for a net debit, as the premium paid for the lower strike call will be greater than the premium received for selling the higher strike call. 

The bull call spread is technically a form of vertical spread. Vertical spreads are options strategies that involve opening long (buying) short (selling) positions simultaneously, with the same underlying asset and expiration, but with different strike prices. With a vertical spread, both of the options must be of the same type – both puts or both calls. 

The preferred outcome for a bull call spread is for the price of the underlying asset to rise above the higher strike call option (the short call) at expiration. In this scenario, both options expire in-the-money, and the difference between the strike prices (less the net debit) represents the maximum gain.

On the other hand, if the price of the underlying asset remains below the lower strike call option at expiration, the position will incur the maximum loss, which is limited to the net debit paid when entering the trade.

Investors and traders may also want to consider the impact of volatility on a bull call spread, prior to entering this type of position. Generally speaking, an increase in implied volatility tends to benefit the long call option more than the short call option (due to their relative vega components), potentially benefiting the overall value of the spread before expiration. On the other hand, a decline in implied volatility may have the opposite effect. 

Another consideration with vertical spreads is the impact from time decay. As options approach their expiration date, their extrinsic value typically diminishes. This natural decay tends to affect the long call more than the short call (due to their relative theta components), particularly if the underlying asset's price does not increase as anticipated. Therefore, traders need to be mindful of time decay when choosing the strikes and expiration dates for the options in the spread.