Spread strategies are simple options strategies for traders to implement. These multi-leg strategies involve two or more options transactions. A spread strategy like the Bull Call Spread works best when a trader’s outlook towards the stock or index is moderate and not aggressive. For instance, a trader can have a moderately bullish or bearish outlook on the stock or the index.
Published on 04 April 2022
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The Bull Call Spread is one of the most popular spread strategies. It is a two-leg spread strategy with ATM and OTM options transactions. But, it is also possible to create the spread with other strike prices.
What is the Bull Spread Strategy?
Suppose you have been monitoring a particular stock or index in the downtrend. It has hit a 52-week low and is expected to reverse from this support. However, since the stock is still in the downtrend, there is no guarantee of its reversal.
The Bull Call Spread strategy suits such a scenario as the trader is moderately bullish on the stock and expects the underlying price to rise.
The objective of adopting the strategy is to ascertain the potential value of investment while limiting the losses and risks. The strategy suggests the simultaneous buying and selling of call options on the same security and expiration dates but at different strike prices. If you expect the underlying price of the stock or index to increase significantly, you mustn’t adopt a bull call spread.
The core identifying tenets of a bull spread strategy include higher premiums on the purchased options than the sold options and upfront investment. The spread is also called a debit call spread.
When to Use a Bull Call Spread?
The below-mentioned trading situations are apt for implementing a bull spread strategy.
Expensive calls: You must use a bullish spread strategy when calls are expensive. It is because the price of the long call is covered by the cash inflow from the short call.
The expectation of a moderate upside: It makes sense to apply the strategy when the trader expects a moderate upside instead of significant gains. If there is an expectation of huge gains, hold the long calls to maximise profits. If there are substantial increases in the security’s price, the short call leg caps gain in a bull call spread.
Leverage is desired: When a trader wants to use funds for maximum benefit, it is advisable to indulge in options trading. The bullish call spread is no exception. The strategy gives the trader more leverage than the outright purchase of the security for a particular amount of investment.
Limited perceived risk: The maximum loss a trader can incur with this strategy is the net premium paid for the position. The tradeoff is capping of the potential return to limit this risk profile.
Benefits of the Bull Call Spread Strategy
One of the first benefits of the strategy is that it limits the perceived risk to the net premium paid for the position. The trader does not have any risk of runaway losses unless he closes the long call position while the short call position is open and the price of the security increases eventually. Also Read about Put Option Buying
Additionally, it is possible to tailor the strategy to the trader’s risk profile. A conservative trader can maintain a narrow spread with a small difference between the higher strike price and the lower strike price. This spread will minimise the net premium spending while limiting profits on the trade. Conversely, an aggressive trader can choose a wider spread for maximising profits even if there is a need to spend more on the position.
The risk-reward profile of the strategy is measurable and quantifiable. If the bullish outlook of the trader works out, the transactions can be profitable. If not, the trader knows the maximum amount of loss.
The Bull Call Spread Example
Mr Shukla buys a Call option at a strike price of ₹3200, paying ₹150 as the premium and sells a Call option at a strike price of ₹3400, earning ₹30 as the premium. The net premium paid for the options equals ₹120, which is the maximum loss.
The bullish call spread strategy suggests buying a call option with a lower strike price (ITM) and selling a call with a higher strike price (OTM). It brings the break-even point down to ₹3350 (3200+150).
Conclusion
A bull spread strategy is right for moderately bullish traders who expect the underlying price of a stock or an index to rise. It uses two call options to create a bull call spread with a lower strike price and a higher strike price. When a trader buys and sells call options, both need to be of the same expiry series and consist of the same number of options. The strategy limits the risks and the rewards.
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All You Need to Know about Shorting in Futures & Options
Shorting is just a simple market view. Just like people purchase stock when they expect it to go up, they sell it when they expect it to go down. It's normally a directional outlook and nothing else.
Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
All You Need to Know about Shorting in Futures & Options
Shorting is just a simple market view. Just like people purchase stock when they expect it to go up, they sell it when they expect it to go down. It's normally a directional outlook and nothing else.
Futures and Options are two important standardised derivative contracts. It is standardised based on the quantity, price, and expiration date. Therefore, quantity based on the lot size is a vital aspect that helps you engage and settle a futures or options contract.
A futures contract is nothing but an improvised forwards contract. It is designed to retain the fundamental transactional structure of a Forwards market. Futures Contracts also eliminate the risks that are generally associated with a Forwards Contract.
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