Bull Call Spread (Debit Call Spread)

Bull Call Spread (Debit Call Spread)

Last Updated on 2025-01-18 by Admin

 

The Bull Call Spread (also known as a Debit Call Spread) is a popular options trading strategy used when an investor has a bullish outlook on an underlying asset but wants to limit both the cost and the risk of the trade. The strategy involves buying a call option at a lower strike price and selling a call option at a higher strike price, both with the same expiration date.

 


Key Elements
  1. Buy a Call Option (Long Call): The trader buys a call option with a lower strike price, which gives the right to buy the underlying asset at that strike price.
  2. Sell a Call Option (Short Call): The trader sells a call option with a higher strike price, which obligates them to sell the underlying asset at that strike price if the option is exercised.
  3. Same Expiration Date: Both call options have the same expiration date.

This strategy is called a “debit spread” because the trader pays a net debit to enter the position, meaning the cost of buying the call option is higher than the premium received from selling the other call.

 


Objective

The main goal of a Bull Call Spread is to profit from a moderate increase in the price of the underlying asset while limiting both the cost of the trade and the risk. This is done by combining the purchase of a call (which gives unlimited upside potential) with the sale of a call (which offsets part of the cost of the trade, limiting risk).

 


Mechanics of the Trade

  1. Buy a Call (Long Call): The long call option gives you the right to buy the underlying asset at the lower strike price. You pay a premium for this option.
  2. Sell a Call (Short Call): The short call option obligates you to sell the underlying asset at the higher strike price. You receive a premium for selling this option.

The key feature of the Bull Call Spread is that it allows you to capitalize on a moderate upward movement in the underlying asset’s price, but with limited risk.

 

Maximum Profit

  • The maximum profit occurs when the price of the underlying asset rises above the higher strike price at expiration.
  • The maximum profit is the difference between the two strike prices, minus the net premium paid to enter the position.

 

Mathematically

  • Maximum Profit = (Strike Price of the Sold Call – Strike Price of the Bought Call) – Net Premium Paid

 

Maximum Loss

  • The maximum loss occurs if the price of the underlying asset stays below the lower strike price at expiration. In this case, both calls expire worthless, and the trader loses the premium paid.
  • The maximum loss is limited to the net premium paid for the spread.

 

Mathematically

  • Maximum Loss = Net Premium Paid

 

Breakeven Point

The breakeven point occurs when the price of the underlying asset is such that the gains from the long call (the bought call) offset the cost of the trade (the net premium paid). This is calculated as the strike price of the long call plus the net premium paid.

 

Mathematically

  • Breakeven = Strike Price of the Long Call + Net Premium Paid

 

Example

Let’s assume a stock is currently trading at $100. The trader expects the stock to rise moderately but wants to limit their risk.

  1. Buy a Call with a strike price of $100 for a premium of $5.
  2. Sell a Call with a strike price of $110 for a premium of $2.

 

Net Premium Paid

  • The trader pays $5 for the long call and receives $2 for the short call.
  • Net Premium Paid = $5 – $2 = $3 per share.

 

Maximum Profit

The maximum profit occurs if the stock price is at or above $110 at expiration.

  • Maximum Profit = $110 (strike of short call) – $100 (strike of long call) – $3 (net premium paid) = $7 per share.

 

Maximum Loss

The maximum loss occurs if the stock price is below $100 at expiration, as both options would expire worthless.

  • Maximum Loss = Net Premium Paid = $3 per share.

 

Breakeven Point

The breakeven point occurs when the stock price is equal to the strike price of the long call plus the net premium paid.

  • Breakeven = $100 + $3 = $103 per share.

 

Risk/Reward Profile

  • Risk: The risk is limited to the net premium paid for the position, which is the maximum loss.
  • Reward: The reward is limited to the difference between the two strike prices minus the net premium paid.

 

When to Use

  • The strategy is ideal when you have a bullish outlook on an underlying asset, but you expect the price to rise moderately rather than dramatically.
  • It is used when the investor wants to limit risk and reduce the cost of buying a long call option, making it more affordable.
  • The strategy works best in a market where volatility is moderate and you expect the asset to move upwards but not surge too far beyond the higher strike price.

 

Pros

  1. Limited Risk: The maximum loss is limited to the net premium paid, making this a safer alternative to buying a call outright, where the potential loss can be substantial.
  2. Cost-Effective: By selling a call to offset the cost of buying a call, you reduce the overall cost of entering a bullish position. This makes it cheaper than just purchasing a single call option.
  3. Defined Profit and Loss: Both the maximum potential profit and the maximum potential loss are known at the time of entering the trade.

 

Cons

  1. Limited Profit Potential: The profit is capped at the difference between the two strike prices, minus the net premium paid. If the price of the underlying asset rises sharply, the trader will not benefit beyond the higher strike price.
  2. Requires Correct Timing: To be profitable, the underlying asset must rise enough to cover the premium paid (i.e., to reach the breakeven point). If the asset moves too slowly or does not rise at all, the position can result in a loss.
  3. Opportunity Cost: If the underlying asset’s price surges significantly above the higher strike price, the trader misses out on potential profits because of the sold call.

 

Example Summary

  • Stock price = $100
  • Buy $100 Call for $5
  • Sell $110 Call for $2
  • Net Premium Paid = $3
  • Maximum Profit = $7 (if the stock price is at or above $110)
  • Maximum Loss = $3 (if the stock price is below $100)
  • Breakeven = $103 (if the stock price is $103)

 


Conclusion

The Bull Call Spread (or Debit Call Spread) is a cost-effective, limited-risk options strategy for traders who are moderately bullish on an asset. It allows the trader to profit from a moderate upward move in the price of the underlying asset while controlling the potential loss. While the profit potential is capped, the strategy provides a balanced risk/reward profile and is well-suited for situations where you expect the underlying asset to rise, but not too dramatically.

 

Admin