An options strategy that involves purchasing an in-the-money (ITM) call option and selling an out-of-the-money (OTM) call option with a higher strike price

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What is a Bull Call Spread?

A bull call spread, which is an options strategy, is utilized by an investor when he believes a stock will exhibit a moderate increase in price. A bull spread involves purchasing an in-the-money (ITM) call option and selling an out-of-the-money (OTM) call option with a higher strike price but with the same underlying asset and expiration date. A bull call spread should only be used when the market is exhibiting an upward trend.

To determine the maximum profit, maximum loss, and break-even point for a bull call spread, refer to the following formulas:

Consider the following example:

An investor utilizes a bull call spread by purchasing a call option for a premium of \$10. The call option comes with a strike price of \$50 and expires in July 2020. At the same time, the investor sells a call option for a premium of \$3. The call option comes with a strike price of \$70 and expires in July 2020. The underlying asset is the same and is currently trading at \$50. Summarizing the information above:

In writing the two options, the investor witnessed a cash outflow of \$10 from purchasing a call option and a cash inflow of \$3 from selling a call option. Netting the amounts together, the investor sees an initial cash outflow of \$7 from the two call options.

Now, assume that it is July 2020. The table below illustrates theoretical stock prices at the expiration date.

At a price of \$60 or above, the investor’s gain is capped at \$3 because both the long call option and short call option is in-the-money. For example, at the stock price of \$65:

• The investor would gain through its long call position by being able to purchase at a strike price of \$50 and sell at the market price of \$65; and
• The investor would lose through its short call position by having to purchase at the market price of \$65 and selling it to the option holder at \$60.

Factoring in net commissions, the investor would be left with a net gain of \$3.

At a price of \$50 or below, the investor’s loss is capped at -\$7, because both the long call option and short call option are out-of-the-money. For example, at the stock price of \$45:

• The investor would not gain from its long call position; and
• The investor would not lose from its short call position.

Factoring in net commissions, the investor would be left with a net loss of \$7.

Therefore, in a bull call spread, the investor is:

1. Limited to the maximum loss equal to net commissions; and
2. Limited to the maximum gain equal to the difference in strike prices between the short and long call and net commissions.

Applying the formulas for a bull call spread:

• Maximum profit = \$70 – \$50 – \$7 = \$13
• Maximum loss = \$7
• Break-even point = \$50 + \$7 = \$57

The values correspond to the table above.

Visual Representation

The comprehensive example above can be visually represented as follows:

Where:

• The blue line represents the pay-off; and
• The dotted yellow lines represent a long call option and a short call option.

Note that the blue line is simply a combination of the two dotted yellow lines.

The payout table below corresponds to the visual graph above.

Example of a Bull Call Spread

Jorge is looking to utilize a bull call spread on ABC Company. ABC Company is currently trading at a price of \$150. He purchases an in-the-money call option for a premium of \$10. The strike price for the option is \$145 and expires in January 2020. Additionally, Jorge sells an out-of-the-money call option for a premium of \$2. The strike price for the option is \$180 and expires in January 2020.

What are the maximum payout, maximum loss, and break-even point of the bull call spread above?

The net commission is \$8 (\$2 OTM Call – \$10 ITM Call).

Applying the formulas for a bull call spread, Jorge determines the:

• Maximum profit = \$180 – \$145 – \$8 = \$27
• Maximum loss = \$8
• Break-even point = \$145 + \$8 = \$153

To confirm, Jorge creates a payout table:

Benefits and Drawbacks of Using a Bull Call Spread

The primary benefit of using a bull call spread is that it costs lower than buying a call option. In the example above, if Jorge only used a call option, he would need to pay a \$10 premium. Through using a bull call spread, he only needs to pay a net of \$8. In addition to being cheaper, the losses are lower as well. If the stock dropped to \$0, Jorge would only realize a loss of \$8 versus \$10 (if he were to just use a long call option).

However, one significant drawback from using a bull call spread is that potential gains are limited. For example, in the example above, the maximum gain Jorge can realize is only \$27 due to the short call option position. Even if the stock price were to skyrocket to \$500, Jorge would only be able to realize a gain of \$27.

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

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