What is a Bull Spread?
Bull Spread is a strategy that option traders use when they try to make profit from an expected rise in the price of the underlying asset. It can be created by using both puts and calls at different strike prices. Usually, an option at a lower strike price is bought and one at a higher price but with the same expiry date is sold in this strategy.
A bull call spread is also called a debit call spread because the trade generates a net debt to the account when it is opened. The option purchased costs more than the option sold.
What Does Bull Spread Mean?
What is the definition of bull spread? A bull call spread involves two call option strike prices, a lower strike price that is usually exercised in-the-money (strike price < market price), and a higher strike price that is exercised out-of-the-money (strike price > market price). Both call components have the same maturity.
A bull put spread involves two put option strike prices, a higher strike price that is usually exercised in-the-money (strike price > market price), and a lower strike price that is usually exercised out-of-the-money (strike price < market price). Both put components have the same maturity.
How the Bull Call Spread Works
Since a bull call spread involves writing a call option for a higher strike price than that of the current market in long calls, the trade typically requires an initial cash outlay. The investor simultaneously sells a call option, aka a short call, with the same expiration date; in so doing, he gets a premium, which offsets the cost of the first, long call he wrote to some extent.
The maximum profit in this strategy is the difference between the strike prices of the long and short options less the net cost of the options—in other words, the debt. The maximum loss is only limited to the net premium (debit) paid for the options.
A bull call spread’s profit increases as the underlying security’s price increases up to the strike price of the short call option. Thereafter, the profit remains stagnant if the underlying security’s price increases beyond the short call’s strike price. Conversely, the position would have losses as the underlying security’s price falls, but the losses remain stagnant if the underlying security’s price falls below the long call option’s strike price.
Often the call with the lower exercise price will be at-the-money while the call with the higher exercise price is out-of-the-money. Both calls must have the same underlying security and expiration month. If the bull call spread is done so that both the sold and bought calls expire on the same day, it is a vertical debit call spread.
Break even point = Lower strike price + Net premium paid
This strategy is also called a call debit spread because it causes the trader to incur a debit (spend money) up front to enter the position.
The trader will realize maximum profit on the trade if the underlying closes above the short strike on expiration.
How the Bull Put Spread Works
A bull put spread is also called a credit put spread because the trade generates a net credit to the account when it is opened. The option purchased costs less than the option sold.
Since a bull put spread involves writing a put option that has a higher strike price than that of the long call options, the trade typically generates a credit at the start. The investor pays a premium for buying the put option but also gets paid a premium for selling a put option at a higher strike price than that of the one he purchased.
The maximum profit using this strategy is equal to the difference between the amount received from the sold put and the amount paid for the purchased put – the credit between the two, in effect. The maximum loss a trader can incur when using this strategy is equal to the difference between the strike prices minus the net credit received.
A bull put spread is constructed by selling higher striking in-the-money put options and buying the same number of lower striking out-of-the-money put options on the same underlying security with the same expiration date. The options trader employing this strategy hopes that the price of the underlying security goes up far enough that the written put options expire worthless.
If the bull put spread is done so that both the sold and bought put expire on the same day, it is a vertical credit put spread.
Break even point = upper strike price - net premium received
This strategy is also called a put credit spread because the trader will receive a credit (be paid the premium) for entering the position.
The trader will realize maximum profit if the underlying closes above the short strike on expiration.
Why Utilize a Bull Call Spread?
The long call spread can be quite advantageous if you think you can correctly gauge where a stock may stall out . It also serves as a less costly alternative to the long call, when option premiums are running higher than usual — ahead of earnings, for instance. So, if you want to bet bullishly on a stock, and you’re willing to sacrifice theoretically unlimited profit potential for reduced risk and lower breakevens, the long call spread may be the strategy for you.