Bull Call Spread Options
Key Takeaways
- A bull call spread is a strategy which includes two call options: a long call option with a lower strike price and a short call option with a higher strike price
- The strategy can benefit traders who expect a moderate increase in the price of the underlying cryptocurrency
- As the strategy includes a short option, the premium received for its sale offsets the expenses for purchasing a long option
What is a Bull Call Spread?
The bull call spread is a strategy that consists of two call options with identical expiration dates but distinct strike prices. One of them is a long call option, and another — a short call option. The short option should have a higher strike than the long option. Such an approach enables a trader to take advantage of a modest increase in the price of the underlying asset. Simultaneously, it mitigates possible losses resulting from an abrupt price decline.
Understanding a Bull Call Spread
The main goal of the bull call spread is to benefit from the growth in the underlying asset's price. In order for the strategy to be profitable, the price should be in the range between two strike prices until the options' expiration date. At most, the price can reach a level just one point above the short option’s strike price.
Call Option Explained
A call option represents a derivative agreement for a purchase of the underlying crypto asset in a specified quantity and at a predetermined strike price prior to the expiration date. The strike price is typically higher than the market price. As a buyer of the option, you open a long call position, which is illustrated in the picture below.
Investors opt for call options when they anticipate a substantial likelihood of the rise in the price of the underlying asset in the future. If the asset's price surpasses the strike price, the call option's buyer may exercise their right to obtain the asset at the strike price. Subsequently, they will sell it at the market price, thereby generating a profit.
While the call option grants the holder the right to acquire the asset, at the same time it obliges the option writer to sell the asset. For this risk, the seller who opens a short position charges a premium.
Thus, the bull call spread results in a net debit, as you offset the price paid for the call option by the money received from the short option sale.
Bull Call Spread Example
Here's a quick example of a bull call spread for Bitcoin. For instance, the current BTC price is $20K. You will open two positions:
- Long call option with a strike price of $22,000 for a $200 premium;
- Short call option with strike price of $25,000 for $500 premium.
Thus, the net value of the position will be equal to $300 (which means the maximum potential loss is also $300). At the same time, the maximum potential profit will be $2,700 (the difference between the strike prices minus the net value of the position). The breakeven point is at the level of $22,300.
Outlook
Investors use the bull call spread when they expect the price of the asset to rise. The price forecast can be based on a variety of factors such as economic indicators, political events, news about a company or industry and technical analysis.
Motivation
The motivation for option traders is the ability to profit from the increase in price of the underlying asset and limit the potential losses.
Variations
Depending on different factors, such as the price of the asset, volatility level, etc., you may utilize the variation of the strategy. For example, you may adjust strike prices upwards or downwards, alter the quantity of options, and so on.
Max Loss
The maximum loss is confined to the position's net value. This loss can occur if the underlying asset's price drops beneath the strike price of the long call option upon expiration, causing both options to lose their value.
Max Gain
The highest achievable gain a trader can obtain from a bull call spread is restricted to the disparity between the call options' strike prices, minus the position's net value.
Profit/Loss
Both the potential profit and loss are limited. The position is profitable when the price of the underlying asset moves above the strike price of the long call option. And vice versa, when the price of the asset moves below the long option strike price, the position will result in a loss.
Breakeven
For the bull call spread, the breakeven point for the strategy is can be calculated as a sum of the long option strike price and the position's net value.
Volatility
Given that the bull call spread comprises one long and one short call, with their prices altering nearly simultaneously when the underlying asset's price changes, volatility exerts minimal influence on the resulting gains.
Time Decay
Time decay is a process in which the price of an option decreases over time. The effect of time decay usually increases closer to the expiration date. Since the strategy includes a call and a short option, the position does not lose value as much as a single call option would.
Assignment Risk
The risk of assignment occurs when the buyer of a call option requires the seller of the option to exercise it. Such risk can occur when the price of the underlying crypto asset exceeds the strike price of the sold call option. To minimize the risk of over-allocation, the position can be closed before the options expire.
Expiration Risk
There is also a risk that options may expire before the underlying asset price reaches the desired level. This risk can be minimized by choosing an option expiration date that gives enough time for the price of the underlying crypto asset to rise.
How a Bullish Call Spread Works
How Is a Bull Call Spread Implemented?
The execution of the bull call spread strategy primarily involves deciding on the optimal underlying asset, expiration date, and contract size. However, the critical aspect of implementing this strategy lies in the careful selection of strike prices and, thus, determining the spread size between them.
How Can a Bull Call Spread Benefit You?
The strategy will generate a profit if an upward direction of the underlying asset's price movement is expected. Moreover, it can be used to protect an existing crypto position.
Underlying Asset & Bull Call Spread Premium
Prior to implementing the strategy, it is recommendable to check the options trading parameters on different platforms. Depending on the specific broker, the underlying asset and the prices for the option premiums may vary. The premium prices are especially important, as they determine the cost of buying or selling the options. Thus, they may affect your net debit and overall profitability of the strategy.
Benefits and Drawbacks of a Bull call Spread
Formulas for Bull Call spread
Here are the formulas for calculating the maximum profit and loss of the strategy, the breakeven, and the position debit:
Maximum Potential Profit = Short Call Strike Price – Long Call Strike Price – Net Debit Position;
Maximum Potential Loss = Net Debit Position;
Breakeven point = Strike price of Long Call Option + Net Debit Position;
Net position debit = Long Call Strike Price – Short Call Strike Price.
Visual Representation
The bull call spread can be visually represented with a payout chart. The picture below shows the potential maximum profit and loss for various prices of the underlying crypto asset at the time of expiration. The break-even point is between the two strike prices.
Example of a Bull Call Spread
We will use a bull call debit spread example to illustrate the strategy. That is, the premium for a purchased option will be higher than the premium for the sold option.
Let's imagine that the current Bitcoin price is $20,000. The trader expects the BTC price to rise, but wants to limit the potential loss if the price starts to decline.
In order to implement the bull call spread, the trader buys 100 call options on BTC with an exercise price of $22,000 for $50,000. Simultaneously, they sell 100 call options on Bitcoin with an exercise price of $25,000 for $20,000.
Thus, the trader will pay $30,000 for the bull call spread ($50,000 for buying options – $20,000 for selling options). It is the net value of the position and the maximum potential loss.
If the BTC price goes up to $25,001 by the options' expiration date, the trader will get the maximum potential profit of $270,000:
Short Call Strike Price – Long Call Strike Price – Net Debit Position
$25,000 × 100 (contract size) — $22,000 × 100 (contract size) – ($50,000 – $20,000)
If the Bitcoin price falls below $22,000, the trader will incur a maximum potential loss of $30,000:
Maximum Potential Loss = Net Debit Position = $50,000 – $20,000
If the Bitcoin price stays between $22,000 and $25,000, the profit will depend on the difference between the market price and the exercise price of the first call option.
How to Set up a Debit Spread Option
To set up a bull call spread as a debit spread option, the investor needs to follow these steps:
- Select a suitable underlying asset;
- Take into account the current market situation and make a prediction regarding future changes in the price of the asset;
- Determine the strike price and expiration date of the options that correspond to the trader's forecast;
- Buy a call option with a lower strike price;
- Sell a call option with a higher strike price;
- Pay a net debit on the trade;
- Monitor market conditions, position, and make decisions to change strategy if necessary.
Market Outlook
Price forecast is a crucial step for an effective execution of the bull call spread strategy. Both fundamental and technical information should be analyzed to formulate a projection for the underlying asset's price and evaluate the risks tied to potential price fluctuations.
The optimal price movement for employing a bull call spread strategy is a modest yet consistent increase in the underlying asset's value.
Payoff Diagram
The picture below shows the chart with a payoff diagram which is constructed for the example above.
Entering
In order to enter a bull call spread position, you need to simultaneously purchase a call option with a lower strike price and sell another call option with a higher strike price. The entry price and position size should be set according to your risks and objectives.
Exiting
Importantly, you can exit the bull call spread by closing the position prior to expiration. For that, you will have to redeem a sold call option or sell a bought call option, or do both. The profit or loss will depend on the price of the options at the time the position is closed.
Time Decay Impact
The effect of the time decay on a bullish call spread strategy will depend on the price movement of the underlying crypto asset. The closer the cryptocurrency price to the long call option’s strike price, the more value it loses. On the contrary, it gains value while being closer to the strike price. And in case the price is between the strike prices, the value is almost unaffected by the time decay.
Implied Volatility Impact
The effect of implied volatility (IV) on the bull call spread strategy is that an increase in IV usually increases the value of options. But at the same time, the risk of loss increases, too. That is why traders should be careful and analyze the market as a whole, not just the IV.
Adjusting a Bull Call Debit Spread
The bull call debit spread can be adjusted by buying back the sold call option and selling a new call option with a higher strike price. This can help significantly increase potential profits.
And if the price of the underlying asset begins to fall and approaches the lower strike price, you can consider closing the entire position to avoid potential losses.
Rolling a Bull Call Debit Spread
It is also possible to use a rolling strategy. This tactic involves the trader closing the current position and opening a new position using the same or similar parameters, but with a later expiration date. Thus, a trader extends the life of his position in order to protect his investment or to increase the potential profit.
Hedging a Bull Call Debit Spread
You can hedge the bull call spread by buying a bear put spread. Bear put spread consists of buying a put option with a higher strike price and selling a put option with a lower strike price. It is used to protect against falling prices of the underlying asset.
Similar Strategies
Some similar strategies to bull call spread include Bear Put Spread, Bull Put Spread, Bear call Spread, Long Straddle, Short Straddle, Long Strangle and Short Strangle.
Commissions
There may be fees associated with buying and selling options, which can reduce potential profits. It is important to factor in these costs when considering the profitability of a bull call spread.
FAQ
What Is a Bull Call spread?
A bull call spread is a strategy, which combines the purchase of a call option with the sale of a call option with a higher strike price. This allows the investor to profit from a moderate increase in the price of the underlying asset, while limiting the potential losses that may occur if the prices were to drop.
What Is the Maximum Loss With a Bull Call Spread?
The maximum loss potential of a bull call spread is the net debit paid to enter the trade.
What Is the Breakeven Point for a Bull Call Spread?
The breakeven point for a bull call spread is the sum of the lower strike price and the net debit.
What Is Bull Spread on a Credit?
The opposite of a bull call debit spread is the bull put credit spread. With a bullish credit spread, the investor sells one put option and buys another with a lower strike price. This strategy is used in bear markets when the investor expects the price of the underlying asset to decline.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
