What is a 'Bull Call Spread'
A bull call spread is an options strategy that involves purchasing call options at a specific strike price while also selling the same number of calls of the same asset and expiration date but at a higher strike. A bull call spread is used when a moderate rise in the price of the underlying asset is expected.
BREAKING DOWN 'Bull Call Spread'
Bull call spreads are a type of vertical spread. A bull call spread may be referred to as a long call vertical spread. Vertical spreads involve simultaneously purchasing and writing an equal number of options on the same underlying security, same options class and same expiration date. However, the strike prices are different. There are two types of vertical spreads, bull vertical spreads and bear vertical spreads, which could both be implemented using call and put options.
Bull Call Spread Mechanics
Since a bull call spread involves writing call options that have a higher strike price than that of the long call options, the trade typically requires a debit, or initial cash outlay. The maximum profit in this strategy is the difference between the strike prices of the long and short options less the net cost of options. The maximum loss is only limited to the net premium paid for the options.
A bull call spread's profit increases as the underlying security's price increases up to the strike price of the short call option. Thereafter, the profit remains stagnant if the underlying security's price increases past the short call's strike price. Conversely, the position would have losses as the underlying security's price falls, but the losses remain stagnant if the underlying security's price falls below the long call option's strike price.
Bull Call Spread Example
Assume a stock is trading at $18 and an investor has purchased one call option with a strike price of $20 and sold one call option with a strike price of $25 for a total price of $250. Since the investor wrote a call option with a strike price of $25, if the price of the stock jumps up to $35, the investor is obligated to provide 100 shares to the buyer of the short call at $25. This is where the purchased call option allows the trader to buy the shares at $20 and sell them for $25, rather than buying the shares at the market price of $35 and selling them for a loss. The maximum gain is equivalent to $250, or ($25 - $20) * 100 - $250, less any trading costs.