Advanced Strategies for Options - Bull Call Spread

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Advanced Strategies for Options - 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.

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