How to Construct a Bull Call Spread
Original post by Rocco Pendola of Demand Media
Generally, investors initiate bull call spreads when they have a moderately bullish to bullish view on an option's underlying stock. Most often executed in one transaction, a bull call spread is when you buy a call option and simultaneously sell a call option, with a higher strike price, using contracts with the same expiration month. The income you collect from the written call helps offset the cost of the purchased call, effectively hedging your investment.
Select the call option you would like to purchase to construct one leg of the transaction. You can use in-the-money, at-the-money or out-of-the-money contracts when opening a bull call spread. When you enter this transaction in your brokerage account, select "Buy to Open." For, assume the purchase of a call with a $30 strike price represents one leg of a bull call spread.
Sell (or write) a call option with a strike price that is higher than the one you purchased. In your account, you sell to open to initiate this leg of the bull call spread. Following the the example from the previous step, you could sell a call on the same stock with the same expiration date and a $35 strike to complete the bull call spread. You can select any strike to sell as long as it is higher than the strike on the call option you purchased in the first leg of the spread.
Monitor the position. If both options expire in the money, which is when the underlying stock rises above the price of the higher strike, you will in most cases realize maximum profits. On the other hand, you will generally lose your entire investment if the underlying stock price falls below the lower strike, and both the purchased and sold call expire worthless.
Tips & Warnings
- The most you can lose on a bull call spread is the debit paid to open the trade.
- Maximum profits on a bull call spread stand at the difference between the two strike prices, minus the debt you paid to open the spread. For example, if you bought a call with a $30 strike and sold one with a $35 strike and the spread cost $2, your maximum profit is $3. Because options use a multiplier of 100, your maximum gain in this example is $300.
About the Author
As a writer since 2002, Rocco Pendola has published numerous academic and popular articles in addition to working as a freelance grant writer and researcher. His work has appeared on SFGate and Planetizen and in the journals "Environment & Behavior" and "Health and Place." Pendola has a Bachelor of Arts in urban studies from San Francisco State University.