Bull call spread - Buy Lower Strike Call, Sell Higher Strike Call
Strategies...
- Buy lower strike calls (prefer at-the-money or slightly out-of-the-money)
- Sell same number of higher strike calls with the same expiration date.
- Ensure the trend is upward.
Example...
Hewlett-Packard Company (NYSE:HPQ) is trading at $22.50 on May 26, 2012.
- Buy the Nov 2012 $22 call option for $2.20.
- Sell the Nov 2012 $28 call option for $0.40.
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| Bull Call Spread |
Why Buy Call? You're bullish on this stock and expect stock price will rise.
Why Call Writing? You can improved opportunity for profit with reduced risk. It's cost $2.20 to buy a call, you gain $0.40 by selling a call. You initial cost has reduced to $1.80.
How does Bull Call Spread work?
Stock price rises to $30...
- Buy the Nov $22 Call = In-the-money,gain $8,
- Sell the Nov $28 Call = Call exercised by buyer, loss $2
- Net premium paid: $ 2.20 - $0.40 = $1.80,
- Profit : $8.00 - $2.00 - $1.80 = $4.20
Stock price traded at $23.80...
- Buy the Nov $22 Call = In-the-money,gain $1.80,
- Sell the Nov $28 Call = Call not exercises, $0
- Net premium paid: $ 2.20 - $0.40 = $1.80,
- Profit : $1.80 - $1.80 = $0
Stock price traded at $20...
- Buy the Nov $22 Call = Out-of-the-money, not exercise the call.
- Sell the Nov $28 Call = Call not exercises, $0
- Net premium paid: $ 2.20 - $0.40 = $1.80,
- Profit : -$1.80
Gain/Loss Table...
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| Bull Call Spread |
Disadvantage? Capped upside if the stock rises higher than $28.
Maximum Loss : $2.20-$0.40=$1.80
(premium paid - premium received = net paid)
Maximum Profit : $6.00-$1.80=$4.20
(Different in strike - net paid)
Breakeven : $22.00+$1.80=$23.80
(Lower strike + net paid)
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