What is a Bull Vertical Spread?
A bull vertical spread is used by investors who feel that the market price of a commodity will appreciate but wish to limit the downside potential associated with an incorrect prediction. A bull vertical spread requires the simultaneous purchase and sale of options with different strike prices, but of the same class and expiration date.
The Basics of a Bull Vertical Spread
There are two types of bull vertical spreads—a call or a put. A call vertical bull spread involves buying and selling call options, while a put spread involves buying and selling puts.
The bull part looks to take advantage of a bullish move, while the vertical part describes having the same expiration. Thus, a bull vertical spread look to profit from an upward move in the underlying security. The real advantage of a vertical spread is the downside is limited. Still, the upside remains limited.
How to Use a Bull Vertical Spread
Investors that are bullish on an asset can put on a vertical spread. This entails buying a lower strike option and selling a higher strike one, regardless of whether it’s a put or call spread. Bull call spreads are used to take advantage of an event or large move in the underlying.
Of the two types of bull vertical spreads, the bull call vertical spread includes buying an in the money call and selling an out of the money call. Bull call vertical spreads are best used when volatility is low.
Then there’s the bull call vertical spread, which involves selling an out of the money put and buying an out of the money further from the underlying price. These types of spreads are best used when volatility is high.
Bull Vertical Call Spreads
The max profit of a bull call vertical spread is the spread between the call strikes less the net premium of the contracts. Break-even is calculated as the long call strike plus the net paid for the contracts.
For a bull put vertical spread, the investor will receive income from the transaction, which is the premium from selling the higher strike put less the cost of buying the lower strike put option. The max amount of money made in a bull put vertical spread is from the opening trade. Break-even is calculated as the short put strike less premium received for the put sold.
Bull Vertical Spread Example
An investor looking to bet on a stock moving higher may embark on a bull vertical call spread. The investor buys an option on Company ABC. Shares are trading at $50 a share. The investor buys an in the money option with a strike price of $45 for $4 and sells an out of the money call with a strike price of $55 for $3.
At expiration, the price of Company ABC’s stock trades at $49. In this case the investor would exercise their call, paying $45 and then selling for $49, netting a $4 profit. The call they sold expires worthless. The $4 profit from the stock sale, plus the $3 premium and less the $4 premium paid, leaves a net profit of $3 for the spread.