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Friday September 03, 2010 |
Advanced Strategies for Options -
Vertical Spreads - Bull Call Spread
We
know that spreads are those strategies where an investor buys one
option contract and sells another with a higher strike price for
the same underlying security.
As
you might have guessed, a bull spread is one where the position
achieves its maximum profit if the underlying common stock rises
in price. Consider
this example.
The
stock market has been volatile but George believes Dupont shares
will rise in price. Because
he is not extremely confident he decides to participate in any
advance for Dupont shares by using a bull spread.
With Dupont common stock trading at $85 he places the
following order. He
buys one contract of the Dupont December 80 call at cost of $5.75
per contract. He
simultaneously sells one contract of the Dupont December 90 call
for net proceeds of $1.50 per contract.
George's cost for this transaction is a net debit of $4.25
per contract or $425. Now
let's run through the possibility at expiration for this position.
Results
for Dupont Bulls Spread using calls
|
Dupont
Share Price at Expiration
|
Profit
for December 80 calls
|
Profit
for December 90 calls
|
Total
Profit
|
|
75
|
($575)
|
$150
|
($425)
|
|
80
|
($575)
|
$150
|
($425)
|
|
84.25
|
($150)
|
$150
|
0
|
|
85
|
($75)
|
$150
|
$75
|
|
90
|
$425
|
$150
|
$575
|
|
95
|
$925
|
($350)
|
$575
|
|
100
|
$1,425
|
($850)
|
$575
|
As
we can see, George's' strategy works very well unless the common
stock falls to $80, the lower strike price in this spread. We can also see that George breaks even if the common stock
ends at $84.25, the value of the lower strike price plus the net
debit. Finally,
George "makes out" like a bandit if the common stock
trades to the higher strike price.
Bull
Spread Review
Bulls
spreads may be implemented using either puts or calls and it is
considered to be a strategy best used if the investor is
moderately bullish for the underlying common stock. The strategy offers both limited risk and limited reward.
Risk and reward is determined by the strike prices selected. Generally, out-of-the-money bull spreads offer greater
reward but much more risk.
For
Bull Spreads Using Calls
1. The transaction always creates a debit because the lower
strike price for a call will always be greater in value than the
higher strike price.
2. The maximum loss is limited to the net debit
3. The break-even point for the spread is equal to the lower
strike price plus the
net debit.
4. The maxim profit is determined by the difference between
the two strike price less
the net debit.
advanced
option strategies 
bull put spread
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Vertical
Spreads > Bull Call Spread
