Bull Call Spread Strategy

 

“The Bull Call strategy is a limited risk/limited reward play”

 

The bull call spread is one of four variations of the vertical spread strategy.

 

Expectations

Employ this strategy with an expectation for the stock price to move higher.

 

Setup/Construction

Buy one call option of a lower strike price and simultaneously sell a call option of a higher strike price.

WARNING – The bull call spread consists of a short option contract. Be aware of the obligations! (being short a call has the obligation of selling 100 shares, if assigned)

 

Example Bull Call Spread

Example trade on SPY etf. Click to Enlarge.

Max Reward/Loss

Max reward is strike width minus debit = $1 – $.58 = $.42 or $42

Max loss is debit paid = $.58 or $58

The horizontal sections of the blue line indicate the maximum profit and the maximum loss. Also notice the point where the blue line crosses the zero (0) line, this point is the break even point at expiration for this particular trade.

 

Share Price Assumption

Price will increase prior to expiration.

Given that assumption buying a long call might be a more appropriate play but why might the Bull Call be preferred?

Well simply, the Bull Call is much lower risk(cheaper). The ATM long call may cost 5 times the amount or more to initiate and it comes down to confidence and timing of the expected move. Also, the bull call is a hedged position so theta is mitigated(to a degree).

 

Bull Call vs Long Call

Long call: Suppose the share price of SPY rose $1 to 219.86 and you had bought the long call for $3.42. From delta, we can estimate an increase in the long call option of $.48, all things constant (they never are). Thus, a $48 dollar gain on your purchase price of $342 equals ~14% return.

Bull call: Again suppose the share price of SPY rose to $219.86 but this time you bought the Bull Call for $.58. From position delta we estimate an increase in the Bull call of $4.60, all things constant. Thus, a $4.60 gain on your purchase price of $58 equals ~8% return.

Now, I know what you’re thinking… the percentage return was lower but keep in mind so was our initial investment, in fact substantially lower. Just remember it all comes down to risk vs reward as related to current market conditions (up/down/sideways).

 

Key Benefits of the Bull Call Strategy

– Low cost

– Hedged position

– High rate of success

 

The Greeks

In this example I’m no longer looking at just one contract, I’m looking at a position(multiple contracts). As such the greeks from all positions are simplified down to one number. Known as position delta, vega, theta, or gamma, respectively.

 

An Example;

Long Call delta = 45
Short call delta = -40
Position delta = 5

 

And so on for each of the greeks. Position delta is just the simplified figure that is the total of every option position you may have in a portfolio.

 

Volatility

For this example, IV is relatively low at 13.73%. IV rank is also low at about 1%. If an increase in volatility does materialize premiums will swell as a result. If IV drops however premiums will deflate.

 

Liquidity

As always, be sure to view open interest, volume, and bid/ask spreads for each leg of this option spread.

 

Probability ITM/OTM

Take a look at the circled percentages at the top of the P/L diagram. These are the probabilities that this position will expire in or out of the money. In this example, I have a 44% chance of being ITM at expiration.

 

Final thoughts on Bull Call Spreads

I’ll avoid the lengthy final thoughts section I provided on the long call strategy page. I would still compile the information the same way but there isn’t any reason to rehash it again here. If you wish to review, visit the long call strategy page.

What I will say in relation to the Bull call spread is, I like it! Along with the other vertical spreads, I trade them often based on my assumption of the market.

With regards to this example, I don’t love the risk/reward payoff of $58/$42 I usually, at worst attempt to be 50/50 and often even better than that.

Got questions about the Bull Call Strategy. Ask me below!

 

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