Bull Call Spread is an option trading strategy used in bull market condition. This strategy can be used by both beginners & traders as they are easy & effective to implement.
Know everything about this options trading strategy here.
About Bull Call Spread
A Bull Call Spread is an options trading strategy that can be used by the traders if they have a bullish outlook for an underlying security.
It is one of the most commonly used options trading strategies by both beginners and experts when they feel that the price of the underlying security will rise significantly.
A Bull Call Spread is also used as a cheaper alternative to a long call by many traders because it involves both writing and buying calls.
In terms of complexity, the Bull Call Spread is fairly easy as it involves only two transactions, as discussed.
The act of writing some calls helps to offset the cost of buying other calls. Although it is important to note that this limits your profits.
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When to go for a Bull Call Spread?
One must go for a Bull Call Spread only when they have a bullish outlook for the market, and they feel that the price of the underlying security will rise significantly. In simple words, the Bull Call Spread can be used as an alternative to a long call.
The only difference between the two would be the margin requirement and profit potential. In case of a long call, the trader has to pay the entire premium to buy a call, but that is not the case with Bull Call Spread.
In this, the trader writes a certain call and uses that premium to buy another call. This transaction helps in reducing the upfront cost of buying calls, and thus it reduces the capital requirement too.
How a Bull Call Spread works?
The strategy mentioned above requires the trader to get into two transactions at the same time. The trader first needs to buy ATM calls for a particular security and write OTM calls for the same.
Doing so will create a debit spread because the premium received after writing the calls would be lesser than the premium paid for buying the calls.
In case of a Bull Call Spread, the buyer needs to consider two major factors that are the strike price and expiry date.
The strike price is the target price at which you feel the security will rise, and the date of expiry is the date at which the option contract will expire.
If you feel that the price of an underlying security will increase in a short period, then try buying calls with a short expiry and vice versa.
Another major factor which you need to consider is the strike price. Since the strategy requires two transactions, you must choose the strike price for both calls after a thorough analysis.
Ideally, it is advisable to buy ATM calls with a strike price equal to that at which the security is trading and write OTM.
The calls you choose to write should be of the strike price till where you expect the security to rise.
Let’s take a few examples to get a better understanding of the strategy:
Nifty Spot: 8000 Lot Size=75
But ATM Call with strike price 8000 for premium: 100
Total Premium Paid: 75*100=7500
Sell OTM Call with strike price 8100 for premium: 60
Total Premium Received: 75*60= 4500
Net Premium: 100-60=40 [A debit spread is created in this case]
Nifty Rises to 8100
Sell ATM Call, which has now become ITM for a premium of 200
The OTM Call written will now become worthless, which implies a premium of 0
Net Profit: 200(Sell price of call) -100(Buy price of call)-40(OTM Call written)= 60*75= 2250
The ATM call with a strike price of 8000 will now become In the Money, and therefore the premium will rise. Sell the call with strike price 8000 for a premium of 200 at the time of expiry.
On the other hand, the calls written will become worthless at the time of expiry. Therefore the total profit earned in this case would be 60 points.
Nifty stays at 8000
In this case, both the calls will become worthless by the time of expiry. This implies that the ATM call with strike price 8000, which was bought at a premium of 100, has become 0, and the call with strike price 8100, which was written at a premium 60, will become 0 too.
Therefore the net loss, in this case, would only be the amount of debit spread i.e., 40 points.
Net loss: 100(buy price of ATM call) -60(premium received for writing calls) = 40
The cases, as mentioned earlier, were two major scenarios depicting the maximum profits and losses which can be earned by implementing these strategies.
The maximum profit in Case 1 would be 60 points on a lot of 75, while the maximum loss would be 40 points, as depicted in Case 2.
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Risk Involved in Bull Call Spread
As mentioned above, the Bull Call Spread is used as a cheaper alternative to a long call. This is because the trader buys a certain call by paying a premium and sells another for which he/she receives a premium.
Therefore, an upper limit is placed on both the profits and losses. In the trades turns unfavourable, the maximum loss incurred is the difference between the premium received and the premium paid.
At the same time, the maximum profit would be the difference between the selling price of the ATM call and the net premium paid. The amount of profit/losses can be managed by choosing the strike price accordingly.
Advantages of the strategy:
- The act of writing calls and using the premium to buy other calls reduces the upfront cost of buying the specific call. This implies a lower margin requirement.
- Although the profits in this strategy are limited, the trader can choose the strike prices accordingly to increase their chances of higher profits.
- The execution of this strategy is simple as it involves only two transactions. It is because of this simple execution that this strategy is widely used.
Disadvantages of the strategy:
- Since there are two transactions involved, the amount of commission you pay to the broker will increase as compared to a long call.
- If the price of the security rises beyond your strike price, you won’t be able to earn extra profits as your profits would be limited. However, you can choose the strike price accordingly.
Conclusion: Bull Call Spread
If you have a bullish outlook for the underlying security and you feel that the price will rise significantly, you can either go for a long call or a Bull Call Spread.
In most cases, Bull Call Spread is used as an alternative when you do not have the available margin required for buying long a call.
Using a Bull Call Spread helps you in earning profits from a bullish market, but at the same time, it limits your profits as well as losses.
However, you can choose the strike price for the calls after analyzing the security thoroughly. This will help you in managing the amount of profit you earn by using the Bull Call Spread.
So, if you are looking for a simple strategy that can help you make money in a bullish market. Then by using less margin & at the same time by playing safe, a Bull Call Spread should be your go-to strategy.
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