What is Bull Call Spread Strategy: Trading options can be highly profitable in financial markets, but it can also be challenging. Fortunately, there are numerous option strategies that can increase our chances of success. One such strategy is the Bull Call spread.
In this article, we will explain what is Bull Call Spread Strategy and explore the different elements, benefits, strategies & more
What is Bull Call Spread Strategy?
A bull call spread is a two-legged options strategy that is used when the expectations from a security are moderately bullish in nature. It is a net debit strategy that starts earning profits as the price of the underlying asset increases.
This strategy utilizes two call option contracts consisting of a long call(buy) at a higher strike price and a short call consisting of an even higher strike price. Here, the contracts that are bought and sold should be of the same security and should be of the same expiry.
The bull call spread consists of two components:
- Buy a call option contract: This can be an ATM or OTM contract
- Sell a put option contract: This should be an OTM contract that has a higher strike price than the call contract bought
Let us now understand this strategy with an example of the Nifty 50. Considering the current spot price of the nifty 50 as 19400 here are the 2 legs to buy to set up a bull call spread strategy:
- Buy a call option contract at a strike price of 19450
- Sell a call option contract at a strike price of 19550
There is no restriction on the number of call contracts that are bought and sold. But, it should be done in equal proportions. For instance, if you purchase two lots of call option contracts, you should similarly sell two call option contracts at a higher strike price.
Thus, one can benefit from the upside through the call option bought and simultaneously reduce the total premium paid through the call option sold. It should also be noted that the level at which you choose to sell the call option contract should be based on where you predict the market will not reach.
Bull Call Spread Strategy
Max profit with bull call spread strategy
The maximum profit in this strategy is limited due to the call option contract being sold at a higher strike price. It can be calculated by subtracting the net premium paid from the difference between strike prices bought and sold.
Let’s make this simpler to understand with the help of an example of the Nifty 50 index.
Example: Suppose the spot price of Nifty 50 is 19400. You buy one call option at the strike price of 19450 and sell one call option at the strike price of 19550. If the premium that is paid and received is Rs.95 and Rs.50 respectively. The following will be the maximum profit in this strategy:
Maximum Profit = (Strike price of CE sold- Strike price of CE bought) – Net premium paid
Maximum Profit = (19550 – 19450) – (95 – 50)
Maximum Profit = (100) – (45)
Maximum Profit = Rs.55
In this example, the maximum profit a trader can earn from this strategy is Rs.55 from a single unit of a lot. Therefore, the profit earned from the entire lot will be Rs.55*50 units (Nifty lot size) which is equal to Rs. 2750.
Max loss with bull call spread strategy
The maximum loss is limited to the net premium paid while executing this strategy. Considering the figures from the examples mentioned above, the following will be the maximum loss in this strategy.
Maximum Loss = Premium Paid – Premium Received
Maximum Loss = 95 – 50
Maximum = Rs.45
Therefore, the profit earned from the entire lot will be Rs.45*50 units (Nifty lot size) which is equal to Rs. 2250.
But, If one were to only purchase a call option contract at the strike price of 19550, then the total loss would be Rs.95*50 units = Rs.4750
Break-even point of bull call spread strategy
The break-even point symbolizes the point where one would neither earn a profit nor incur a loss. The break-even point for the bull call spread can be calculated by adding the net premium paid to the call option that is purchased.
Suppose you purchase a call option at the strike price of 19450 and sell a call option at the strike price of 19550 by paying a net premium of Rs.45. Then your break-even point would be:
Break-even point = Long call strike price + Net premium paid
Break-even point = 19450 + 45
Break-even point = 19495
This means you would start earning profits when the nifty will move beyond the level of 19495.
Benefits of the Bull Call Spread Strategy
The following are the benefits of a bull call spread strategy:
- Reduced Costs: A bull call strategy is cheaper than buying a naked call option as you receive a certain amount of premium from the call option sold.
- Limited Losses: Since the maximum loss for the buyer of the options contract is limited to the net premium paid, executing a bull call spread strategy will also reduce your potential maximum loss.
- Flexible Strike Prices: There is no fixed range in which one has to buy and sell the call options contract in order to execute a bull call spread strategy. The strike prices for this strategy can be adjusted as per the market outlook and personal preferences of the trader.
Capped Gains: Although the bull call spread strategy limits the total cost and losses, it also limits one potential gain. As we sell a call options contract at a higher strike price in this strategy, we forfeit the gains above the strike of the sold call option.
As we conclude our article on the topic of ‘What is Bull Call Spread Strategy’, it is worth noting that this is a versatile tool. It enables options traders to benefit from upward price movements while maintaining a controlled level of risk. Although the profit potential is limited, this strategy is appealing because it strikes a balance between gains and risk management.
Written By Aaron Vas
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