Call Debit Spreads (Bull Call Spread)

With the call debit spread you will buy one call and sell one call further from the money to lower the cost of the trade. It will cap your max profit but also reduce your max loss and breakeven price.

A bull call spread is a vertical spread. It consists of two calls with the same expiration but different strikes prices. The strike price of the short call (the one you sell) is higher than the strike of the long call (the one you buy), which means that you will incur a debit. The short call’s main purpose is to help pay for the long call’s upfront cost.

In the image above you can see on the options chain how a bull debit spread would be put on.

EXAMPLE

  • Long 1 GSX 60 call
  • Short 1 GSX 60.5 call

MAXIMUM GAIN

  • High strike – low strike – net premium paid

MAXIMUM LOSS

  • Net premium paid

The benefit of a higher short call strike is a higher maximum to the strategy’s potential profit. The disadvantage is that the premium received is smaller, the higher the short call’s strike price.  

Outlook

Looking for a steady or rising stock price during the life of the options. As with any limited-time strategy, the investor’s long-term forecast for the underlying stock isn’t as important, but this is probably not a suitable choice for those who have a bullish outlook past the immediate future. It would require an accurately timed forecast to pinpoint the turning point where a coming short-term dip will turn around and a long-term rally will start.

Summary

This strategy consists of buying one call option and selling another at a higher strike price to help pay the cost. The spread generally profits if the stock price moves higher, just as a regular long call strategy would, up to the point where the short call caps further gains.

Motivation

Profit from a gain in the underlying stock’s price without the up-front capital outlay and downside risk of outright stock ownership.

Variations

A vertical call spread can be a bullish or bearish strategy, depending on how the strike prices are selected for the long and short positions. See bear call spread for the bearish counterpart.

Max Loss

The maximum loss is very limited. The worst that can happen is for the stock to be below the lower strike price at expiration.  In that case, both call options expire worthless, and the loss incurred is simply the initial outlay for the position (the net debit).

Max Profit

The maximum profit is capped at expiration, should the stock price do even better than hoped and exceed the higher strike price. If the stock price is at or above the higher (short call) strike at expiration, in theory, the investor would exercise the long call component and presumably would be assigned on the short call. As a result, the stock is bought at the lower (long call strike) price and simultaneously sold at the higher (short call strike) price. The maximum profit then is the difference between the two strike prices, less the initial outlay (the debit) paid to establish the spread.

Profit/Loss

Both the potential profit and loss for this strategy are very limited and very well-defined: the net premium paid at the outset establishes the maximum risk, and the short call strike price sets the upper boundary beyond which further stock gains won’t improve the profitability. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.

Breakeven

This strategy breaks even at expiration if the stock price is above the lower strike by the amount of the initial outlay (the debit). In that case, the short call would expire worthless and the long call’s intrinsic value would equal the debit.

Breakeven = long call strike + net debit paid

Credit to https://www.optionseducation.org and theocc.com for the educational description.

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