Bull call spreads are also known as call debit spreads. They are a bullish options trading strategy that involves buying a call and then selling another call out of the money with the same expiration date. This combination process lowers the break-even price on the trade.
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What Are Bull Call Spreads?
Bull call spreads are a bullish option strategy that limits your trading risk. It consists of buying a long and short call strike with the same expiration date. The short call reduces the theta and delta of your contract. Buy a call and sell a call.
Bull call spreads have many names. Bull call debit spreads, long call spreads, and vertical spreads are all common names that refer to the same options strategy. Put, you’re just buying and selling a call.
It’s called a bull call debit spread because a debit is taken upon entering the trade. Sounds exciting. Well, it should be. Regardless of where you are in your trading journey, learning how to build bull call spreads will be a powerful tool in your trading toolkit. Keep reading, and I’ll show you how bull call spreads can work for you!
A bull call spread is the strategy of choice when investors feel the underlying asset’s price (i.e., commodities, bonds, stocks, currencies, etc.) will only go up a small amount shortly.
High Volatility
Traders will employ this strategy most often during times of high volatility. Bull call spreads benefit from the short option’s rising stock price and time decay.
Therefore, how do you build bull call spreads? A long call spread gives you the right to buy a stock at strike price A and the obligation to sell at strike price B if the contract is assigned.
BC spreads can be implemented by buying an at-the-money call option while simultaneously writing a higher striking out-of-the-money call option of the same underlying security and the same expiration month.
In other words, you buy one ATM call and sell 1 OTM call. Our trading service goes in-depth into options trading.
Building Bull Call Spreads
To create a bull call spread, you use two call options; the first with a lower strike price (A). The second with an upper strike price (B). Here’s a handy tip: you’ll want to pick an asset you think will go up in value over the next few days, weeks, or months.
Here’s How It Looks:
- Buy one call option that has a strike price ABOVE the current market price with a specific expiration date based on your analysis. This is also known as a long call option. Pay the premium.
- Sell a one-call option with a higher strike price. This is known as a short-call option. Ensure this call option has the same expiration date as the long call option in step 1. You will receive a premium as the seller of the call option.
Bull Call Spreads Example
Instead of just buying a long call option, you can build a bull call spread to minimize your risk or chance of losing money. I can’t emphasize how important this is in the trading game.
Selling a cheaper call with a higher strike B helps to offset the cost of the call you buy at strike A. The result is a BC spread that reduces the cost of the option.
Moreover, it limits your risk since you can only lose the net cost to create the spread. So far, so good.
However, there is some bad news. You will have to sacrifice some potential profits to get the risk reduction. As a result, the gains in the stock’s price are capped if the stock price skyrockets; you miss out on potential gains that are not so good.
Bull Call Spread Expirations
- The stock price falls below the call option you purchased (A). Because of this, the investor chooses not to exercise the option. Therefore, it expires worthless. As a result, they lose the premium paid to purchase the option. If they exercise the option, they would have to pay more—the selected strike price—for an asset currently trading for less. Which, in my opinion, doesn’t make fiscal sense.
- The stock price exceeds the strike price of the call option you sold (B). Because of this, the investor exercises their first option as it has a lower strike price. They can purchase the shares for less than the current market value.
A Real Life Example
Let’s take American Airlines (AAL) for ease of understanding bull call spreads. Let’s say it’s currently trading at $42. However, you feel it will increase due to news of a merger.
As a result, you decide to buy a $40 JUL call for $300 and write a $45 JUL call for $100. All in all, the investment required for this spread is $200.
Sure enough, share prices of AAL start to increase and close at $46 on the expiration date. What this means is both options expire in the money.
Moreover, the $40 and $45 JUL calls have an intrinsic value of $600 and $100 respectively. In other words, the spread you entered into is now worth $500 at expiration. Once you subtract the cost to enter the trade ($200) from the total worth ($500), you’re left with $300.
On the other hand, if AAL share prices dived $38 (no pun intended), both options expire worthless. You’ll lose the $200 it costs to enter the spread, which is your maximum potential loss.
Break Even Point = Strike Price of Long Call + Net Premium Paid.
Maximum Gains and Losses
There is a maximum profit with bull call spreads. Maximum gain is reached when the stock price moves above the higher strike price of the two calls. Your potential profit is equal to:
Strike Price A – Strike Price B – Net Premium Paid – Commissions
What’s the maximum loss incurred with bull call spreads? The great news is that your maximum loss cannot exceed the initial debit taken to enter the spread position.
This will occur when the underlying security price exceeds the long call’s strike price. Our goal with trading is to cap loss. As a result, bull call spreads are popular for doing just that.
The Sweet Spot
You want the stock price to be the same or above strike price B at expiration. However, you don’t want the strike so far above that you’re disappointed you didn’t simply buy a call on the underlying stock.
However, if this happens, look on the bright side. You played it smart and made a profit. And that’s always a good thing.
Many times, traders get in trouble trying to make too much money. How’s that possible? The stock market trades on the emotions of greed and fear.
When you allow greed to control your trading, you often take losses. You never go broke taking your profits. Even small ones.
Check out our trading room as we discuss trading with risk management.
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Pros of Bull Call Spreads
Bull call spreads are cheaper than buying an individual call option by itself. Therefore, you’re saving money and minimizing risk.
You don’t have to use much capital to own the stock. As a result, a good way to grow a small account is trading spreads.
They limit the maximum loss of owning stock to the net cost of the strategy. In other words, your max loss is less with bull call spreads.
Cons
If the stock’s price goes above the strike of the call option sold on bull call spreads, you miss out on the gains. However, minimizing risk is more important than making huge gains every time.
Making huge gains on every trade isn’t realistic. Slow and steady wins the race. As a result, it’s better to be safe than sorry.
The net cost of the premium paid limits gains. Therefore, bull call spreads are a great complement to riskier trading styles. You can trade any style with the right stock training.
Another downside to bull call spreads is the risk of early assignment of the short stock option position.
Final Thoughts: Bull Call Spreads
Closing bull call spreads close to expiration gives you maximum value. If you close your position before expiration, you’ll want as little time value as possible remaining on the call you sold. You may wish to consider buying a shorter-term long call spread, e.g., 30-45 days from expiration.
If you’re a beginner or seasoned trader, trading options and bull call spreads are powerful tools when traded correctly. You must develop a strategy before trading options.
Therefore, you don’t lose your hard-earned money. We want to see you succeed.
If you need more help, take our options trading course.
Frequently Asked Questions
Here's an example of a bull call debit spread. Underlying security is trading at $70. Buy the $65 call and sell the $75 call with the same expiration.
Bull call spreads are a bullish options strategy that allows traders to profit when a stock increases without much risk and spending a lot of capital to enter the trade.
Traders exit a bull call spread buy (STC) selling to close the long call option and (BTC) buying to close the short call option. A profit will be realized if the spread is sold for more than it was purchased.
