In this article today, we will discuss the bull call spread option strategy. The bull call spread is a multi-legged strategy. The level of risk is predefined and has limited profit potential. When you are expecting the price rise of the underlying asset before the contract expires, this is the best strategy to implement.
The bull call spreads are made up of call options. In this strategy, traders buy the call option contracts and sell the same at a higher price. The strategy's main purpose is to take advantage of the price hike of an underlying asset before it expires. The rise in volatility can also help traders to earn profit using this strategy.
Market outlook of Bull call spread:
A bull call spread is used when the traders believe that the underlying asset's price will increase before its expiry. This strategy is also very common with the name call debit spreads because traders have to pay a premium to buy the contracts. But don't worry; the overall risk of the strategy is limited to the premium paid at the initial stage.
How to set up the Bull call debit spread strategy?
To enter a bull call debit spread, traders have to buy a long call option and sell a short call option at a high strike price. The amount paid initially will be the only amount at risk. Earlier, we said the profit potential is limited; let us understand how. The total profit of this strategy will be the spread width minus the premium. To reach the breakeven point of this strategy, the stock price must rise more than the premium paid to enter the strategy.
If the underlying stock's price is closer to the strike price, meaning if there is not much price gap between both the costs, traders have to pay a higher premium, and the chances of an option expiring in-the-money will increase. The wider the spread width between the short and long calls, the more traders have to pay a premium, but the profit potential will rise in this case.
Understanding the diagram of Bull call spread
You can see the amount of risk and reward highlighted in the diagram. To enter a bull call spread, you must pay a premium, the maximum loss on the strategy. The short call option is sold to reduce the strategy's overall cost. The max profit is limited to the width of the spread minus the debit paid initially.
Let us take an example and make it more clear:
Suppose ₹ 5 wide bull call spread has cost ₹ 2 as a premium. If the stock price of the underlying asset is above the short call at the time of expiry, the trader will have a maximum profit of ₹ 300. In case the stock closes below the long call option, the trader will have a max loss of ₹ 200.
How to enter the bull call debit spread?
To enter the bull call debit spread, traders must go for the buy-to-open (BTO) call option and sell-to-open (STO) call option at the high strike price. Both the contacts must have the same underlying asset and the same strike price. By entering into the bull call debit, traders have to pay a premium, but when they sell the call option at a higher price, the overall cost of strategy will reduce, and it will also define the total risk.
As we have already seen in the above example, a trader has bought a call option at ₹50 and wants to sell the same call option at ₹55. If the cost of the premium to enter the strategy is ₹2, then the max profit will be limited to only ₹300, and also, the max loss is defined at -₹200.
Buy-to-open ₹50 call option contracts
Sell-to-open ₹55 call option contract
How to exit from the bull call spread?
Traders may exit from the bull call spread strategy by reversing the order of the position, that is, by selling-to-close (STC) long call option and buying-to-close (BTC) short call. Suppose the spread is sold at a higher price than it was bought; the trader will automatically realize a profit.
Some additional notes on this strategy:
The time decay factor or theta is against this strategy.
The implied volatility is a friend of this strategy and may lead traders to profit.
In adverse market scenarios, this strategy can be adjusted by adding a bear put debit spread, having the same strike price and underlying asset.
If the price has not moved as per your prediction, and the strategy is not profitable, you may roll the strategy to the later expiry date; for that, sell the existing spread and enter a new one with the new expiry dates.
So, we have seen which strategy you can implement if the price of the underlying stock is going to rise before the contract expires. If you face any questions or doubts, please get them clarified by reaching us at 8447445815 / 9909978783