In a bull call spread strategy, you simultaneously buy call options at a specific strike price while selling the same number of call options at a higher strike price. Both call options share the same expiration date and underlying asset.
This vertical spread strategy is often employed when you are bullish on the underlying asset and anticipate a moderate rise in its price. By using this strategy, you accept a cap on your potential profit. However, you benefit from tying up less capital compared to other strategies such as buying calls outright or initiating a covered call trade. This creates a trade with a favorable reward-to-risk ratio if the underlying stock price makes only mild moves higher.
For this strategy to be executed properly, the stock price must increase to generate a profit. 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. This is how a bull call spread is constructed.
Let’s consider an example to illustrate this strategy:
Purchase a call option with a strike price of $50, expiring in one month, for a premium of $3.
Sell a call option with a strike price of $55, expiring in one month, for a premium of $1.
The net cost of this bull call spread is:
The maximum profit occurs if the stock price is at or above the higher strike price ($55) at expiration:
The maximum loss is the net cost of entering the spread:
The break-even point is the lower strike price plus the net cost:
Limited to the net cost of the spread.
Limited to the difference between the strike prices minus the net cost.
Lower strike price plus the net cost.
This strategy is particularly useful when you expect a moderate increase in the underlying asset’s price and want to limit your risk while reducing the capital required for the trade.