This places your total entry cost at $8 per share or $800 for a standard contract (100 shares). A bull call spread is set up with a net debit (or net cost) and makes profit as the price of the underlying stock increases. Any option strategy that contains short options is at risk of early assignment. The risk is most acute when a short option is in-the-money and has very little time value left. When this occurs, both options expire in-the-money and you make a profit equal to the spread less the initial debit when you entered the position. No matter what happens, a trader can not lose more than their premium paid.
You could decide to close out your positions so as to minimize your risk. The max loss is always the premium paid to own the option contract minus the premium received from the off-setting call option sold; in this example, $42 ($60 – $18). We begin by discussing the two call option strike prices involved in a Bull Call Spread, the risk-defined aspects of the https://www.bigshotrading.info/ technique, and how profits and losses are calculated. Although some traders try to achieve maximum profit through assignment and exercise, if your profit target has been reached it may be best to close the bull call spread prior to expiration. The bull call spread resonates with a broad spectrum of traders, primarily because of its defined risk-reward ratio.
Pros of the Bull Call Spread Strategy
I suppose at this stage you may be wondering why anyone would choose to implement a bull call spread versus buying a plain vanilla call option. Quantitative Perspective – The stock is consistently trading between the 1st standard bull call spread strategy deviation both ways (+1 SD & -1 SD), exhibiting a consistent mean reverting behavior. However there has been a sudden decline in the stock price, so much so that the stock price is now at the 2nd standard deviation.
We’ve all been there… researching options strategies and unable to find the answers we’re looking for. Delve into its pros and cons to gauge its fit for your trading goals and risk appetite. It’s a favorite for those who have a rosy outlook on a stock but don’t want to put all their eggs in one basket.
Breakeven stock price at expiration
The biggest disadvantage of a bull call spread is the effects of time decay, known in the options world as “theta.”, one of the greeks. A bull call spreae may be out on at varying times based on the trader’s goals, risk tolerance and market conditions. Because the spread is bullish, it is important to try to initiate it when prices are likely to continue rising or stage a bullish reversal. As its name suggests, a bull call spread may be used when the investor is bullish on a market and wants to potentially profit from higher prices.
This is particularly true will call options when traders will exercise their call option in order to receive an upcoming dividend. Like vega, theta also changes depending on where the stock price is trading. Using our earlier example of ABC stock trading at $54, say we were right about the price increasing and the stock rallies to close at $58 on the expiration date. The purpose of the short call is to mitigate some of the overall costs of the strategy at the expense of putting a ceiling on the profits.
It is also known as a “long call spread” and as a “debit call spread.” The term “bull” refers to the fact that the strategy profits with bullish, or rising, stock prices. The term “long” refers to the fact that this strategy is “long the market,” which is another way of saying that it profits from rising prices. Finally, the term “debit” refers to the fact that the strategy is created for a net cost, or net debit.
However, this strategy also caps potential losses to the net premium paid. The effects of changes in the underlying asset’s price, volatility, and time decay also play a crucial role in the strategy’s outcome. Before you construct a bull call spread, it’s essential to understand how it works. Normally, you will use the bull call spread if you are moderately bullish on a stock or index. Your hope is that the underlying stock rises higher than your breakeven cost.
Example of a Bull Spread Option Strategy
The long call option increases in value, but the short call option also starts to gain in value, which reduces the overall profit. From the P&L graph above, you can observe that this is a bullish strategy. For this strategy to be executed properly, the trader needs the stock to increase in price in order to make a profit on the trade. The trade-off of a bull call spread is that your upside is limited (even though the amount spent on the premium is reduced). When outright calls are expensive, one way to offset the higher premium is by selling higher strike calls against them.
It enables options traders to benefit from upward price movements while maintaining a controlled level of risk. Although the profit potential is limited, this strategy is appealing because it strikes a balance between gains and risk management. This strategy thrives on balance, offsetting weaknesses with strengths. Your earnings peak when the asset’s price matches or surpasses the higher strike price at expiration, and losses are primarily the net premium you initially shelled out.
The strategy entails the buying and selling of either a call or put with different strike prices but with the same expiration date on the same underlying security or asset at the same time. While the long call in a bull call spread has no risk of early assignment, the short call does have such risk. Early assignment of stock options is generally related to dividends, and short calls that are assigned early are generally assigned on the day before the ex-dividend date. In-the-money calls whose time value is less than the dividend have a high likelihood of being assigned. Therefore, if the stock price is above the strike price of the short call in a bull call spread (the higher strike price), an assessment must be made if early assignment is likely.