Payoff Diagram

Description

The bull call spread option trading strategy is employed when the options trader thinks that the price of the underlying asset will go up moderately in the near term.

Steps Involved

The bull call spread involves the purchase of a call on a stock, while simultaneously selling a higher strike call with the same expiration date. The same number of contracts are bought and sold, and the trade is placed as a tailor made combination to ensure both legs are filled at the same time. Often the bull call spread is often categorized as a vertical spread which is a category of option spreads involving the same stock, same expiration month but different strike prices.

Rational

Minc Trading use the bull call spread when moderately bullish on a stock or the market. The advantage of the strategy is its ability to be designed around an expected move in the underlying. For example, if extremely bullish on an underlying, one would buy an OTM Call and sell an even further OTM call. The advantage over a bought call is there is very limited time decay and the ability to buy back sold calls for a profit if the stock doesn't move in the short term.

Alternatively an investor could buy ITM calls and sell ATM calls and generate significant profits if a stock simply remains at its current level. As a result of the time decay on the sold calls, this can be an extremely profitable strategy, when moderately bullish on the underlying, however not expecting a significant rally, as time decay actually works in your favor.

Selecting Strike Prices

The more bullish the outlook, the higher the selected strike prices. This changes the risk profile, and potential returns significantly. A thorough analysis of the payoff diagram using various strike prices should be considered prior to entering a bull call spread.

 Delta should also be considered when determining the distance between the strike prices. A delta of 0.25 should be a minimum however above 0.3 is preferred. This allows us to pick up a reasonable return from any stock movements. The lower the delta, the smaller the return if an underlying rallies prior to expiry. At expiry, the delta is always 1:1.

Break Even Points

Break evens are calculated by taking the low strike price (bought call) and adding the cost of entry (net debit). This gives you a break even level at expiry, prior to expiry, the position begins profiting as soon as the stock rallies and can be closed at any time prior to expiry.

Past Trade Recommendations

09/11/09: AMP - Bull Call Spread 74% return in 1 day

 06/11/09: Asia Pacific Holdings (AXA) - Bull Call Spread  110% Profit in 3 days

 07/10/09: BHP Billiton (BHP) - Bull Call Spread 30.1% Profit in 12 days

See all our past trades