Bull Call Spreads

Definition

The term bull call spread refers to a vertical spread consisting of two calls with the same expiration date but different strike prices.  Bull call spreads produce a near term cash outflow in exchange for a possible longer-term cash inflow.

Explanation

A bull call spread is a strategy that includes both a short call option as well as a long call option.  The strategy is used when an investor would like to profit from a stock that increases in price, without the risk of an upfront capital investment.  With a bull call spread, the strike price of the short call is higher than that of the long call.  While the sale of the short call can help pay for the long call's upfront cost, a bull call spread requires an initial cash outflow.

As a reminder, a short call involves the sale of a call option, which gives the holder the right, but not an obligation, to buy the stock at the strike price.  Buying a long call gives the investor the right to buy the stock at the strike price.  In this strategy, the long call places a cap on the investor's upside gain.  However, the short call's premium lowers the overall cost of taking this position.

The maximum profit generated by this strategy occurs if the underlying stock's price exceeds the higher strike price on the short call.  When this happens, the investor would exercise their long call and be assigned on the short call.  This provides the investor with the opportunity to buy the stock at the lower price of the long call and sell it at the higher price of the short call.  The investor's profit would be the difference between the two strike prices, less the initial cash outlay.

The maximum loss occurs when the stock price remains below both the short and long call's strike price at expiration.  If this happens, both options expire out-of-the-money, and the investor's loss is equal to the initial cash outlay.

The breakeven point for a bull call spread occurs when the stock's price is above the long call strike price (the lower strike price) by the amount of the initial cash outlay at expiration.  When this occurs, the short call expires out-of-the-money and the long call's intrinsic value would be equal to the initial cash outlay.

Related Terms

assignment, adjustment, cash-backed call