CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
You’ll also notice that the two calls create a window between a ceiling (max profit) and a floor (max loss). Here is something you should know, wider the spread, higher is the amount of money you can potentially make, but as a trade off the breakeven also increases. Given this you expect the stock price to react https://www.bigshotrading.info/ positively to the result announcement. However because the guidance was laid out in Q2 the market could have kind of factored in the news. This leads you to think that the stock can go up, but with a limited upside. The spread strategies are some of the simplest option strategies that a trader can implement.
Real-Life Example of Bull Call Spread
As with any options trading strategy, various potential factors can have an effect on how the trade will play out. The ideal market forecast for a bull call spread is “modestly bullish,” or that the underlying asset’s price will gradually increase. Investors use a bull call spread when they’d like to take advantage of a slightly bullish trend in a stock without taking too much risk. This type bull call spread strategy of options trading strategy limits both profits and losses, making it a popular strategy for investors with limited capital and a desire for downside protection. The maximum gain occurs when the underlying stock price increases and closes above the strike price of the sold call on the expiration date. Predicting the bull call spread’s financial outcomes requires a sharp eye on variables.
If the stock price is above the lower strike price but not above the higher strike price, then the long call is exercised and a long stock position is created. If the stock price is above the higher strike price, then the long call is exercised and the short call is assigned. The result is that stock is purchased at the lower strike price and sold at the higher strike price and no stock position is created.
What Is a Bull Spread Option Strategy?
When outright calls are expensive, one way to offset the higher premium is by selling higher strike calls against them. For example, suppose an investor buys 100 shares of stock and buys one put option simultaneously. This strategy may be appealing for this investor because they are protected to the downside, in the event that a negative change in the stock price occurs. At the same time, the investor would be able to participate in every upside opportunity if the stock gains in value. The only disadvantage of this strategy is that if the stock does not fall in value, the investor loses the amount of the premium paid for the put option.
I say usually, because you’ll see further down in this post why it can be really important to understand gamma risk. ABC is currently trading at $54 so you buy a call at 50 for $300 and write a call at 56 for $100. Losses are also capped, in this case by the debit taken when you execute the trade.
Cons of the Bull Call Spread Strategy
Using our earlier example of ABC stock trading at $54, say we were right about the price increasing and the stock rallies to close at $58 on the expiration date. Today we’re looking at the bull call spread, a bullish trade with a good risk to reward ratio. This trade is a nice way to take a long exposure on a stock without risking too much capital. By balancing these pros and cons, you’re better positioned to harness the strategy effectively amidst the dynamic world of options trading. Having a visual like the graph above clearly shows that is meant by “spread”.
Start by purchasing a call option with a lower strike price—it’s your ticket to potential gains. Then, sell another call option, with a higher strike price on the same asset, and ensure they both have the same expiration date. This strategy is an added layer of defense and a buffer against potential pitfalls. While selling a call does limit how high you can profit, it also trims your initial cost and reduces downside risk. Think of the bull call spread as your way of dipping into bullish territory with a safety harness—there’s a ceiling, but also a cushion. In the P&L graph above, you can observe that the protective collar is a mix of a covered call and a long put.
It should be noted that the maximum profit in a bull call spread is limited to the difference between the strike price of the two call options, less the net premium paid. The maximum loss is limited to the net premium paid to establish the spread. The worst that can happen is for the stock to be below the lower strike price at expiration. In that case, both call options expire worthless, and the loss incurred is simply the initial outlay for the position (the net debit).
- By balancing these pros and cons, you’re better positioned to harness the strategy effectively amidst the dynamic world of options trading.
- Here are a bunch of graphs that will help you identify the best possible strikes based on time to expiry.
- The spread does come with some disadvantages as well that should be carefully considered.
- This strategy provides the opportunity to profit from an upward price movement while limiting potential losses.
- With proper understanding and implementation, bull call spreads can be an effective tool for achieving investment objectives.
- The goal is to profit from an upward price movement in the underlying asset while minimizing the potential for losses.
- For example, in the example above, the maximum gain Jorge can realize is only $27 due to the short call option position.
In writing the two options, the investor witnessed a cash outflow of $10 from purchasing a call option and a cash inflow of $3 from selling a call option. Netting the amounts together, the investor sees an initial cash outflow of $7 from the two call options. Both strategies involve collecting a premium on the sale of the options, so the initial cash investment is less than it would be by purchasing options alone. This formula can be used to calculate the price at which break-even is gained for the bull call spread position. Whether the stock falls to $5 or $50 a share, the call option holder will only lose the amount they paid for the option spread ($42). The net effect of this transaction is that the trader has paid out $42 ($60 paid – $18 received).