Tuesday, July 29th, 2014

Bull Call Spread Options Strategy

 

The bull call spread options strategy is an uncovered options trading strategy. The bull call spread options strategy involves buying and selling call contracts on the same stock, commodity, or currency with the same expiration date. Unlike a long or short straddle options strategy, which require picking contracts at the same price, the bull call spread options strategy involves picking contracts at different prices. This is a strategy for a stock that the trader things will raise moderately in value. The trader buys a call option priced at the current price of the stock. He or she sells a call option for a price significantly higher than the current price. He profits if the stock price rises more than the difference between what he or she paid for the at the money call and what he or she received for the out of the money call.

An Example of a Bull Call Spread Options Strategy

A stock currently sells for $75 a share. You purchase a $75 call option for next month for $3. There is a $90 call option on the same stock priced at $1 a share. You sell a contract for the $90 call. At the very beginning the bull call spread options strategy costs you $200 ($300-$100) as standard options contract are for a hundred shares. As we mentioned above traders engage in this strategy when they expect to see a slight increase in the value of the underlying stock, commodity, or currency. The worst that the trader can do is lose $200 if the stock remains at $75 a share or falls lower through the expiration of the contract. If the stock rises in price, as expected, he can profit. If the stock goes up $2 a share he breaks even (minus fees and commissions). Anything above the $77 range yields a profit. However, if the stock goes up $15 a share he will need to pay on the call that he sold. Thus the maximum that he can make on a bull call spread options strategy is the difference between the selling prices of the two contracts plus profit from the sold contract minus the cost of the purchased contract. In the case of this example it is $13 a share or $1,300 on a $200 investment.

Why Not Just Buy a Call?

As mentioned above a trader uses a bull call spread options strategy when he or she believes that a stock, commodity, or currency will rise moderately in price. He or she uses the profit from selling an out of the money call to reduce investment cost. This limits potential profits but the trader does not expect to see a huge price increase of the stock anyway. This is one of the basic options strategies used by traders to gain profits and hedge investment risk. For one who expects to see a stock, commodity, or currency fall in price a similar options trading strategy for hedging risk can be used with puts.

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