A Bull Call Spread is a trading strategy that involves taking outan equal size long position and short position in Call Options in the same underlying instrument. The possibility of buying and selling the same thing and yet still generating a profit comes about through the use of options with different Strike prices. The objective of the strategy is to capture profits made from a moderate change in the price of the underlying asset and uses options with the same expiration date. It is a strategy that involves limiting losses and also limiting gains.
The strategy requires two trades to be placed but is best explained by first breaking them out and studying them individually.
Long Call Options
Position: Long Call Options
Expiry date: 21/12/2018
Strike Price: $860
The premium (price paid for the option) is $25. When that cost is factored in the Call Options will become profitable when the price of the underlier exceeds $885. Any further price increases in the underlier will result in further profits.
Short Call Options
Position: Short Call Options
Expiry date: 21/12/2018
Strike Price: $880
The premium received from selling the options is $15. When that revenue is factored in, this position will be profitable up to the point where the price of the underlier exceeds $885. Any further price increases in the underlier will result in further losses.
Profit / Loss Analysis
The Bull Call Spread strategy has two positions that cancel each other out once the price of the Underlier exceeds both of their Strike prices. After that point, any gain in one is equal and opposite to the loss made in the other. The fact that they have different Strike prices means that the strategy can make a profit if the underlier makes a moderate gain in price.
When the price of the underlier is equal to or above $870 then the strategy is profitable. The total gain is capped by the presence of Long and Short positions in the same option, but at the same time the total loss is also capped. Should the underlier trade at prices under $870 then the trade will make a loss of up to $10. The $10 figure being the difference between the premium received on the sell trade and the premium paid on the buy trade.
The Bull Call Spread is a type of Vertical Spread because it involves buying and selling the same type of option with the same expiry date, but with different Strike prices. A Bear Put Spread involves using two trades in Call options to anticipate bearish price action in the underlier. Alternatively, Bull Put Spread and Bear Put Spread are bullish or bearish trading strategies that can be put on using Put options.
The purpose of vertical spread strategies is to limit losses should the price action not turn out to be what you expected. The trade-off is that gains are also limited. Whilst the volatility of returns is reduced using the strategy does nothing to mitigate the risk that you might make the wrong call on which way the market is going.