Bull call spread trades make money when stocks rise in price. They are a less costly way of betting on higher share prices than simply buying long calls alone.
If you expect a stock will go up in value but you are not quite certain in your outlook, the bull call options spread may be a good choice because it can make money if you are right but will lose less if you are wrong than buying bullish call options outright.
The flipside is that you will also not make as much money if a stock rises compared to buying call options alone.
Think of the bull call as a lower risk and lower reward way of betting on markets rising than simply buying calls.
When you expect a share price to rise moderately, a bull call spread is an attractive options strategy. If you thought it could rise by a lot, then buying calls would be a better bet because their upside potential is not limited.
Table of Contents
- How To Make Money When Stocks Rise: Bull Call Spread
- Bull Call Spread Basics
- How To Buy A Bull Call Spread
- Bull Call Spread Risk Graph Example
- Bull Call Spread Tips
- When Should You Trade A Bull Call Spread?
- Which Stocks Work Best For Bull Calls?
How To Make Money
When Stocks Rise: Bull Call Spread
A bull call spread is known as a vertical spread because it combines a lower strike option and a higher strike option in the same expiration month.
The lower strike call option is purchased and the higher strike call option is sold.
The call option you purchase will cost more than the call option you sell pays you, so the combined bull call spread trade will result in a net outlay or debit.
Bull call options spreads are known as debit spreads whereas options spreads that put money into your pocket are known as credit spreads, such as the bull put or bear call.
Almost anytime you place a debit spread, you will need share price movement to profit. In a bull call vertical options spread, you need the underlying share price to rise to make money.
So, when you place a bull call spread, you will need to give the stock some runway to make its move higher.
It is important to select an expiration month sufficiently far into the future so that the stock has a chance to rise.
Another reason you want to choose options some time away from expiration is that time-decay is your enemy when buying a bull call spread.
Unlike credit spreads, which are generally best placed close to an expiration date, and benefit from time-decay, debit spreads are hurt by the options Greek, time-decay.
>> Related: Options Trading For Dummies
Bull Call Spread Basics
When you buy a bull call spread, you will be:
- Buying a lower strike price call option
- Selling a higher strike price call option
Buying calls are bullish wagers that the market will rise higher while selling calls to begin a trade are bearish bets that the market will fall.
So at first glance it doesn’t seem to make sense to both buy a call and sell a call simultaneously for the same expiration month.
But there is more to this position than meets the eye at first glance.
One of the factors that affects an option’s price is called delta, an options Greek. When a stock moves higher by $1, an option will move by a lesser amount usually.
For example, if you buy a call option with a delta of 0.50, and the stock goes up by $1, the call will go up by $0.50.
The reason the gains and losses from the call you buy and the call you sell don’t cancel each other out is the call you buy has a higher absolute delta value than the call you sell.
For example, the call you buy may have a delta of 0.5 whereas the call you sell has a delta of -0.20, so when you sum them, the bull call spread has a combined delta of 0.30.
As the stock rises by $1, the bull call makes $0.30.
It may not seem like much but it generally represents a high percentage gain. For example, if you paid $2 for a bull call and you made a profit of $0.30, the return is +15% on your risk.
How To Buy A Bull Call Spread
To place an order for a bull call spread, you will need to instruct your broker to take the following actions simultaneously:
|Option Type||Action||Strike Price||Expiration|
|Long Call||Buy To Open||Lower||Same month|
|Short Call||Sell To Open||Higher||Same month|
Some options trading platforms cater to virtually any combination of buying and selling of options in order forms called Xspreads.
A nice feature of TastyWorks is that no commissions are charged when closing long options contracts.
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HOW TO CLOSE OUT A BULL CALL SPREAD
When you begin a bull call spread, you enter an order to Buy To Open the long call option contracts and to Sell To Open the short call option contracts simultaneously for the same expiration month.
To close the bull call spread trade, submit a Sell To Close order for the long call contracts and a Buy To Close order for the short call contracts.
>> Options Tip: Enter the same number of long call and short call contracts otherwise if you open more short call contracts than long call contracts, your risk levels would substantially increase – the additional short calls would be called naked calls.
Bull Call Spread Risk Graph Example
ABC stock is trading at $60 per share. You buy a long call at strike $60 and sell a short call at strike $70.
When you buy the long call, you will pay the Ask price for it. And when you sell the short call, you will receive its Bid price.
Long Call Ask Price = $5
Short Call Bid Price = $2
Bull Call Spread Cost = $5 – $2 = $3
By entering an equal number of long and short call contracts, the most you can lose is what you pay for the bull call spread, $3 per share.
An options contract generally corresponds to 100 shares, so to buy 1 long call contract and sell 1 short call contract costs $300.
BULL CALL RISK GRAPH
|Stock Price||Long Call Profit
|Short Call Profit
|Bull Call Profit
At expiration, you can see that the breakeven level of the bull call spread is equal to the strike price of the long call plus the cost of the bull call spread.
So, the breakeven is $60 + $3 = $63
Key Takeaway: If the stock does not rise from $60 to $63 by expiration, the bull call will lose money.
You can also see that the most you can lose in a bull call spread is what you paid for it, which is $300.
And the most you can make is limited to a fixed amount no matter how high the stock rises.
Even when the stock climbs up to $90 per share, the bull call spread profit is capped at $700 per contract.
In general, the maximum reward in a bull call spread is calculated as follows:
Maximum Reward = [Short Call Strike Price – Long Call Strike Price] – Bull Call Cost
Maximum Reward = [$70 – $60] – $3 = $7
So, the most you can make is $7 per share or $700 if one contract of each call option is traded.
Bull Call Spread Tips
LIMIT THE EFFECTS OF TIME DECAY
Although no hard and fast rule exists, the general rule of thumb is to buy bull call spreads at least 4-6 weeks away from expiration.
The reason it could be hazardous to buy a bull call spread with little time to go before expiration is that time decay erodes option premiums exponentially, and time decay accelerates as expiration approaches.
Because a bull call is a debit spread that costs you money, time decay will be your enemy, so limiting its effects by going further out in time is generally a smarter choice.
KEEP BID-ASK SPREAD LOW
Pay close attention to the bid-ask spread. This is the difference between what you pay for an option and what you receive for selling it.
You want the bid-ask spread to be as small as possible, otherwise it eats into your gains.
For example, if our bull call spread made $0.30 when the stock went up by $1, and we wanted to close it for a gain yet discovered that the bid-ask spread for the long call was $0.10 and was $0.15 for the short call, then a whopping $0.25 of our gain would be lost to slippage, the term used for bid-ask spread.
So, make sure to take note of the bid-ask spread before entering a position. Options that are heavily traded, such as those on stocks like Netflix, Facebook, and Twitter, generally have narrower bid-ask spreads.
TRADE THE SAME # OF CONTRACTS
It is very important to buy and sell the same number of contracts.
If you happened to sell more short call contracts than you purchase long call contracts, you would be taking on a lot more risk.
Each additional short call contract that is not covered by a long call contract would technically be a naked call, which theoretically has unlimited risk.
>> Related: Options Trading Basics
PLACE BOTH OPTIONS IN THE SAME EXPIRATION MONTH
A bull call spread is a vertical spread because both long and short call options are placed in the same expiration month.
If you placed either option in a different expiration month, the spread would be classified as a diagonal spread.
BEWARE OF HIGH VOLATILITY
When options have high levels of implied volatility, even greater share price movements may be warranted in order to turn a bull call spread into a profitable trade.
Pay close attention to the delta differential – the difference between the long call and short call delta – when implied volatility is high.
If the bull call spread delta was 0.30 during normal periods but it declined to just 0.10 during periods of high implied volatility, then for each dollar the stock climbs higher, you would only be making $0.10 on your bull call options spread.
When you factor in bid-ask spread, it is difficult to make money in such circumstances without significant share price movement.
When Should You Trade
A Bull Call Spread?
A bull call spread is generally applied when you are moderately bullish.
It makes little sense to place the trade when very bullish because it has limited upside potential. A long call would make much more money if the stock rose by a large amount.
It is less common to be highly bullish on a stock, so a bull call is favored over a long call more often than not.
The risk is lower than owning a long call, and the limited upside potential is a small price to pay for the greater peace of mind knowing that if the stock doesn’t rise higher, the amount lost would be less than buying long calls outright.
Options Tip: To practice the bull call spread without risking any real money, virtual trade or paper trade the options strategy so can see how the options prices change when the stock moves up or down.
If a bull call spread seems intimidating, and an automated investing approach sounds more appealing, consider any one of the leading robo advisors, such as Betterment, who can manage your nest egg automatically.
Which Stocks Work Best
For Bull Calls?
MODERATELY BULLISH TRENDING STOCKS
Bull call spreads work well on bullish trending stocks on the run.
Look for stocks that are ascending higher slowly but steadily to take advantage of a bull call spread.
If you look at a stock chart and discover a share price is very choppy with no obvious trend but lots of volatility, you should probably keep going with your search.
LIQUID STOCKS & OPTIONS
An obscure stock that few people know about or a penny stock is generally going to have options with wide bid-ask spreads or no options at all.
It is likely in your best interests to steer clear of both and favor more popular stocks that are traded heavily, such as Autozone, which have narrower bid-ask spreads as a result.
BE WARY OF STOCKS DUE TO REPORT EARNINGS
Prior to earnings, implied volatilities on options generally spike higher. These spikes often lead to what is called delta compression, where the bull call spread makes less when the underlying stock rises because the difference in option deltas is smaller.
So, even if the stock moves higher as expected, you may not make quite as much as you had hoped.
When companies announce earnings, share price movements can surprise investors positively or negatively.
Placing trades before earnings is a speculative wager that is much like a coin toss, so you can end up losing out in a hurry if you bet bullish and the stock falls.
Sometimes, companies will announce numbers in line with analysts’ expectations and still fall lower because of downgraded future guidance.
The bottom line is you don’t quite know how share prices will react after an earnings announcement, so to put the odds in your favor, bull call spreads are often placed when more clarity in share price can be anticipated.
Have you placed a bull call spread? How did it work out? Did you learn any investing lessons? We would love to hear from you.
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