Diagonal Bull Call Spread Explained

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Bull Call Spread Payoff, Break-Even and R/R

This page explains bull call spread profit and loss at expiration and the calculation of its maximum gain, maximum loss, break-even point and risk-reward ratio.

Bull Call Spread Basic Characteristics

Bull call spread, also known as long call spread, is a bullish option strategy, typically done when a trader expects the underlying security to increase in price, but not too much. It has limited risk and limited upside potential.

A bull call spread position consists of two call options – buying a lower strike call and selling a higher strike call. It is a debit spread (negative cash flow when entering the position), because the price you pay for the lower strike call is typically higher than the price you get for selling the higher strike call.

We will explain the profit and loss profile and the calculation of maximum gain, risk and break-even point on an example.

Bull Call Spread Example

Let’s consider a bull call spread position created by the following transactions:

  • Buy a $45 strike call option for $4.38 per share (after commissions), resulting in initial cash outflow of $438 (assuming one option contract represents 100 shares of the underlying).
  • Sell a $50 strike call option with the same expiration date for net initial price of $2.02, resulting in initial cash inflow of $202.

The total initial cost is $438 paid for the long call option minus $202 received for the short call option, which is $236.

The objective of a bull call spread trade is for the underlying price to increase before the options expire, so that our long call option ends up in the money by such amount that will offset the initial cost and make a profit. Assuming we hold the position until expiration, there are three possible scenarios.

Scenario 1 (Maximum Loss)

The worst case scenario is that contrary to our expectations the underlying price declines and ends up below the lower strike price (in our example $45). Both options expire worthless and there is zero cash flow at expiration. The total loss from the trade is equal to the initial cost, which is $236 in our example.

It does not matter whether the underlying ends up just below $45 or plummets to $30. While our options are worthless at any price at or below $45, we also can’t lose more than what we have initially paid for the position.

Maximum possible loss, or risk of a bull call spread trade is equal to initial cost and applies when underlying price ends up below or exactly at the lower strike.

Scenario 2 (Maximum Profit)

The ideal scenario is that the underlying price goes up and ends up at or above the higher strike at expiration. When this happens, both our call options are in the money.

Let’s say the underlying ends up at $52. We exercise the $45 strike call and gain $7 per share ($52 minus $45), or $700. At the same time, we are assigned the $50 call and lose $2 per share ($52 minus $50), or $200. Combining the two, we gain $500 at expiration, or $5 per share, which is exactly the difference between the two strikes. Because we initially paid $236 for the position, our net profit from the trade is $500 – $236 = $264.

Maximum possible profit from a bull call spread equals the difference between strikes (times number of shares) minus initial cost. It applies when the underlying ends up above or exactly at the higher strike.

Scenario 3 (Between the Strikes)

So we know what happens when the underlying ends up below the lower strike (maximum loss) and above the higher strike (maximum profit). What if it ends up between the two strikes?

Below the higher strike the short call is out of the money. The outcome at expiration therefore depends entirely on the long lower strike call. For example, if underlying price is at $47.67 at expiration, we will exercise the $45 strike call and gain $2.67 per share, or $267. The $50 strike call has no effect. Combined with the initial cost of $236, the total profit from the trade is $267 – $236 = $31.

The higher the underlying price gets above the lower strike, the greater the gain at expiration. As a result, the trade’s profit or loss between the two strikes is increasing proportionally to underlying price. Near the lower strike it approaches maximum loss; near the higher strike it approaches maximum profit.

Bull Call Spread Payoff Diagram

In the graph below you can see how the profit or loss behaves under the different scenarios and how the two options are driving it. The thick blue line represents overall P/L; the green line is the long $45 strike call; the red line is the short $50 call.

Below $45 the payoff is constant – a loss equal to initial cost of the position.

Between $45 and $50 it rises proportionally to underlying price due to increase in the long call option’s value. The short call option is still out of the money.

Above $50 the total P/L is constant and positive, as the lower strike call continues to increase in value, but this increase is now offset by the rising value of the short upper strike call.

Bull Call Spread Break-Even Point

Besides the two strikes, the most important point in the chart is the moment when total payoff crosses zero and the trade starts being profitable – the break-even point. It is the underlying price at which the lower strike call option value is exactly equal to the initial cost of the entire position.

In our example the initial cost is $236, or $2.36 per share, and therefore the break-even point is at underlying price equal to $45 + $2.36 = $47.36.

The general formula for bull call spread break-even point is:

B/E = lower strike + initial cost

Bull Call Spread Risk-Reward Ratio

Knowing the maximum loss (scenario 1) and maximum profit (scenario 2) we can also calculate the risk-reward ratio. In our example, maximum loss is $2.36 per share and maximum profit is $2.64 per share. Risk-reward ratio is therefore 1:1.12.

Below you can see the general formulas:

Maximum loss (risk) = initial cost

Maximum profit (reward) = higher strike – lower strike – initial cost

Maximum profit (reward) = higher strike – B/E

Similar Option Strategies

Bull call spread profit and loss profile is very similar to bull put spread. The difference is obviously that the latter uses puts rather than calls and it is a credit spread (the position is entered with net positive initial cash flow).

Another strategy with similar, bullish payoff is collar. It is best used when you are already long the underlying stock and want to create an exposure similar to bull call spread (limited risk and limited upside).

Bull call spread and bull put spread payoff profiles are inverse to bear put spread and bear call spread, which as their names suggest are bearish strategies (profit when underlying price goes down). The latter is actually the exact other side of bull call spread (you sell the lower strike call and buy the higher strike call).

Bull call spread is also closely related to plain and simple long call, as both are bullish and have limited risk. Compared to long call with the same strike price as the spread’s long call (lower) strike, bull call spread has lower initial cost (due to the cash you receive for selling the higher strike call) and therefore lower break-even point (therefore higher probability of profit, other things being equal). For these benefits you of course pay with limited upside. Therefore, if you think the underlying price might jump substantially, a long call might be a more suitable trade; if you think a greater increase in price is unlikely, a bull call spread might offer lower cost and better odds.

Bull Call Spread Options Trading Strategy Explained

Published on Wednesday, April 18, 2020 | Modified on Wednesday, June 5, 2020

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Bull Call Spread Options Strategy

Strategy Level Beginners
Instruments Traded Call
Number of Positions 2
Market View Bullish
Risk Profile Limited
Reward Profile Limited
Breakeven Point Strike price of purchased call + net premium paid

A Bull Call Spread (or Bull Call Debit Spread) strategy is meant for investors who are moderately bullish of the market and are expecting mild rise in the price of underlying. The strategy involves taking two positions of buying a Call Option and selling of a Call Option. The risk and reward in this strategy is limited.

A Bull Call Spread strategy involves Buy ITM Call Option and Sell OTM Call Option.

For example, if you are of the view that NIFTY will rise moderately in near future then you can Buy NIFTY Call Option at ITM and Sell Nifty Call Option at OTM. You will earn massively when both of your Options are exercised and incur huge losses when both Options are not exercised.

When to use Bull Call Spread strategy?

A Bull Call Spread strategy works well when you’re Bullish of the market but expect the underlying to gain mildly in near future.

Example

Suppose you are bullish on Nifty, currently trading 10,500, and expecting a mild rise in its price. You can benefit from this strategy by buying a Call with a Strike price of 10,300 at a premium of 170 and selling a Call option with a strike price 10,700 at a premium of в‚№60. The net premium paid here is в‚№110 which is also your maximum loss.

Bull Call Spread of NIFTY

Current Nifty 10,500
Option Lot Size 75
Strike Price of Call Option в‚№10,300
Premium Paid в‚№170
Strike Price of short Call Option 10,700
Premium Received в‚№60
Net Premium Paid в‚№110
Break Even Point
(Strike Price of bought call + Net Premium)
10,410

The Bull Call spread strategy has done 3 things:

  • It has brought down the break-even point. If only the Call Option was purchased, the break-even point would have been 10, 470. Now it is 10,410.
  • It has brought down the net premium. If only the Call Option was purchased, the premium paid would have been в‚№170. Now it is в‚№110.
  • It has also brought down the extent of the loss. If only the Call Option was purchased, the maximum loss would have been в‚№170. Now it is в‚№110.

Bull Call Spread Strategy Payoff Schedule

Payoff Schedule

Payoff from
Nifty on Expiry Long Call Option
(SP-BEP)
BEP = 10,470
Max Loss = 12750
Short Call Option
(BEP-SP)
BEP = 10,760
Max Profit = 4500
Net Payoff(в‚№)
9,700 -12750 4500 -8250
9,900 -12750 4500 -8250
10,100 -12750 4500 -8250
10,200 -12750 4500 -8250
10,410 -4500 4500 0
10,600 9750 4500 14250
10,800 24750 -3000 21750

Market View – Bullish

When you are expecting a moderate rise in the price of the underlying.

Actions

  • Buy ITM Call Option
  • Sell OTM Call Option

A Bull Call Spread strategy involves Buy ITM Call Option + Sell OTM Call Option.

For example, if you are of the view that Nifty will rise moderately in near future then you can Buy NIFTY Call Option at ITM and Sell NIFTY 50 Call Option at OTM. You will earn massively when both of your Options are exercised and incur huge losses when both Options are not exercised.

Breakeven Point

Strike price of purchased call + net premium paid

Risk Profile of Bull Call Spread

Limited

The trade will result in a loss if the price of the underlying decreases at expiration. The maximum loss is limited to net premium paid.

Max Loss = Net Premium Paid

Max Loss happens when the strike price of Call is less than or equal to price of the underlying.

Reward Profile of Bull Call Spread

Limited

Limited To The Difference Between Two Strike Prices Minus Net Premium

Maximum profit happens when the price of the underlying rises above strike price of two Calls. The profit is limited to the difference between two strike prices minus net premium paid.

Max Profit = (Strike Price of Call 1 – Strike Price of Call 2) – Net Premium Paid

Bull Call Spread Strategy – The Full Lowdown With Explainer Charts

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Last Updated on November 12, 2020

A Bull Call Spread, also known as a call debit spread, is a bullish strategy involving two call option strike prices:

  • Buy one at-the-money or out-of-the money call.
  • Sell one call further away from the money than the call purchased.

A trader would use a Bull Call Spread in the following hypothetical situation:

  1. A trader is very bullish on a particular stock trading at $50.
  2. The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply owning stock.
  3. The trader expects the stock to move above $52.92 but not higher than $55.00 in the next 30 days.

Buy One Call – Sell One Call

Given those expectations, the trader selects the $52.50 call option strike price to buy which is trading for $0.60. For this example, the trader will buy only 1 option contract (Note: 1 contract is for 100 shares) so the total cost will be $60 ($0.60 x 100 shares/contract).

Also, the trader will sell the further out-of-the money call strike price at $55.00. By selling this call, the trader will receive $18 ($0.18 x 100 shares/contract). The net effect of this transaction is that the trader has paid out $42 ($60 paid – $18 received).

In this situation, the trader is bullish: for example, the price chart shows very bullish action (stock is moving upwards); the trader might have used other technical or fundamental reasons for being bullish on the stock.

Risk Defined & Profit Defined

When a Bull Call Spread is purchased, the trader instantly knows the maximum amount of money they can possibly lose and the maximum amount of money they can make. The max loss is always the premium paid to own the option contract minus the premium received from the off-setting call option sold; in this example, $42 ($60 – $18).

Whether the stock falls to $5 or $50 a share, the call option holder will only lose the amount they paid for the option spread ($42). This is the risk-defined benefit often discussed about as a reason to trade options. Similarly, the Bull Call Spread is profit-defined as well. The max the trader can make from this trade is $208. How this max profit is calculated is given in detail on the Bull Call Spread profit and loss graph on the next page.

Bull Call Spread requires Accurate Predictions

The important part about selecting an option strategy and option strike prices, is the trader’s exact expectations for the future. If the trader expects the stock to move higher, but only $1 higher, then buying the $52.50/$55.00 Bull Call Spread would be foolish. This is because at expiration, if the stock price is anywhere below $52.50, whether it be $20 or $52.49, the spread strategy will expire worthless. Therefore, if a trader was correct on their prediction that the stock would move higher by $1, they would still have lost.

Moreover, if the trader is exceptionally bullish and thinks the stock will move up to $60, then the trader should just buy a call rather than purchase a Bull Call Spread. In this example, the trader would not gain anymore profit once the stock moved past $55. This is explained on the next page.

Bull Call Spread Profit, Loss, & Breakeven

The following is the profit/loss graph at expiration for the Bull Call Spread in the example given on the previous page.

Break-even

The breakeven point for the bull call spread is given next:

  • Breakeven Stock Price = Purchased Call Option Strike Price + Net Premium Paid (Premium Paid – Premium Sold).

To illustrate, the trader purchased the $52.50 strike price call option for $0.60, but also sold the $55.00 strike price for $0.18, for a net premium paid of $0.42. The strike price paid was the $52.50. Therefore, $52.50 + $0.42 = $52.92. The trader will breakeven, excluding commissions/slippage, if the stock reaches $52.92 by expiration.

Max Profit

The max profit for a bull call spread is as follows:

  • Bull Call Spread Max Profit = Difference between call option strike price sold and call option strike price purchased – Premium Paid for bull call spread.

To illustrate, the call option strike price sold is $55.00 and the call option strike price purchased is $52.50; therefore, the difference is $250 [($55.00 – $52.50) x 100 shares/contract]. The net premium paid for the bull call spread is $42. Consequently, the max profit is $208 ($250 – $42). As a sidenote, this max profit occurs when the stock price is at $55.00 (the upper call strike price) or higher at expiration.

Partial Profit

Partial profit is calculated via the following, assuming the stock price is greater than the breakeven price:

  • Bull Call Spread Partial Profit = Stock price – Breakeven price

For instance, the stock closed at $54.00 at expiration. Hence, the stock price at expiration ($54.00) minus the breakeven stock price ($52.92) would mean the trader profited $108 [($54 – $52.92) x 100 shares/contract]

Partial Loss

A partial loss occurs between the lower purchased call strike price and the breakeven stock price. The calculation is given next:

  • Bull Call Spread Partial Loss = Breakeven price – Stock price

For example, a closing stock price at expiration of $52.75 is between the lower strike price of $52.00 and the breakeven of $52.92 and is therefore going to be a partial loss. When calculated, the loss is $17 [($52.92 – $52.75) x 100 shares/contract]

Complete Loss

A complete loss occurs anywhere below the lower purchased call strike price ($52.50) which amounts to the entire premium paid of $42.

Bull Call Spread & Call Option Comparison

The Bull Call Spread is liked by many traders more than simply buying a call option for two main reasons:

  1. Reduces the capital spent/lower breakeven price.
  2. Is a strategy than incorporates reality.

Lower Cost, Lower Breakeven Price

Because a bull call spread involves the selling of an option, the money required for the strategy is less than buying a call option outright. Moreover, the breakeven price is lowered when implementing a bull call spread. To illustrate the cash outlay and breakeven prices for a bull call spread and just a call option are given next:

  • Bull Call Spread: cost $42; breakeven price $52.92
  • Call Option: cost $60; breakeven price $53.10

In percentage terms, the bull call spread is 30% cheaper than purchasing only the call option.

Realistic Expectations

The second advantage/disadvantage of a bull call spread is that this strategy considers the reality and probabilities of a potential move. Theoretically, buying a call strategy has unlimited profit potential. However, successful option traders generally focus on probabilities and take into consideration reality. A stock move from $50 to $55 is a 10% move. This has to occur in the time before expiration, in the example 30 days. In order for a rational options trader to buy just a call, the option trader has to expect a stock move greater than 10% within 30 days.

In conclusion, the bull call spread is a great alternative to simply buying a call outright: the bull call spread reduces the breakeven price and decreases the capital required to be bullish on a stock, it also is a strategy that takes into consideration realistic expectations.

What is Options Spread Strategy?

First things first – let’s learn about options. An option is defined as a contract for the purpose of buying or selling stock at a pre-negotiated price and date. These options are typically sold or bought at 100 shares of the stock per contract. An “option” establishes a contract between a buyer and seller . This allows them to buy or sell assets at certain prices. That price is also known as the strike price. When an option is traded, the buyer can purchase an asset, and the seller must fulfill that transaction. Understanding options strategies make all the difference between success and loss. Chuck Hughes has been an investment champion for years, and his strategies can help you succeed.

You may have also heard about call options. This is a contract where the buyer can buy stock at a certain price within a certain period of time. A put option gives the seller the right to sell stock at a certain price within a specific period of time.

Options strategy is an opportunity to make a profit by buying and selling options in the same class. Options include stocks, bonds, and mutual funds. This works on the same principle as standard trading, but with different elements at work. For many, it is a lot easier and simpler to manage once you have the basic strategies down.

The strike price must go above (for calls) or below (for puts) before the stock can be exercised for a profit (option premium) when trading options.

About Options Spread Trading

When options spread trading, you must analyze the market trends in order to choose the right strategy and follow your trading plan. There are three basic types of options spread trade strategies – vertical spread, diagonal spread and horizontal spread. What does this mean? It’s the relationship between the strike price and expiration date of the options of a specific trade. Knowing the terminology is also key, which helps you adapt to other options strategies. Let’s take a look at these three types:

    Vertical Spread – This is when you move up and down a pricing list to locate options priced differently in the same expiration month with the same underlying security. You also use this process for calls and puts.

Diagonal Spread – A diagonal spread occurs when you move along the expiration date and remain at the same price level.

  • Horizontal Spread – This occurs when yo move along the expiration date and remain at the same price level.
  • When viewing options prices, you will usually see calls on one side of the strike price and puts on the other side. It is also important to know that options spread strategies are known by a number of terms, such as strangle, condor, bull calendar spread, collar and others.

    Building a Better Options Strategy

    There are a number of things you can do to build a better options strategy that works for you. Avoiding simple mistakes is important. Here are a few tips:

      Buy out-of-the-money (OTM) call options with no strategy

    Use the same strategy in different market conditions

    You do into have an exit plan before the trade option expires

    Take crucial risks by doubling up trade options

    Trade options that aren’t liquid

    Wait to repurchase your short options

    You do not factor in the earnings and dividend date into the overall strategy

    You do not know what to do with an early assignment

    You do not use index options for neutral trades

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