A bull spread is an optimistic options strategy designed to profit from a moderate rise in the price of a security or asset. As a type of vertical spread, a bull spread involves the simultaneous purchase and sale of either call options or put options with different strike prices but with the same underlying asset and expiration date. Whether a put or a call, the option with the lower strike price is bought and the one with the higher strike price is sold.
A bull call spread is also called a debit call spread because the trade generates a net debt to the account when it is opened. The option purchased costs more than the option sold.
Key Takeaways
- A bull spread is an optimistic options strategy used when the investor expects a moderate rise in the price of the underlying asset.
- Bull spreads come in two types: bull call spreads, which use call options, and bull put spreads, which use put options.
- Bull spreads involve simultaneously buying and selling options with the same expiration date on the same asset, but at different strike prices.
- Bull spreads achieve maximum profit if the underlying asset closes at or above the higher strike price.
Understanding a Bull Spread
If the strategy uses call options, it is called a bull call spread. If it uses put options, it is called a bull put spread. The practical difference between the two lies in the timing of the cash flows. For the bull call spread, you pay upfront and seek profit later when it expires. For the bull put spread, you collect money upfront and seek to hold on to as much of it as possible when it expires.
Both strategies involve collecting a premium on the sale of the options, so the initial cash investment is less than it would be by purchasing options alone.
How the Bull Call Spread Works
Since a bull call spread involves writing a call option for a higher strike price than that of the current market, the trade typically requires an initial cash outlay. The investor simultaneously sells a call option, aka a short call, with the same expiration date; in so doing, he gets a premium, which offsets the cost of the first, long call he wrote to some extent.
The maximum profit in this strategy is the difference between the strike prices of the long and short options less the net cost of the options—in other words, the debit. The maximum loss is limited to the net premium (debit) paid for the options.
A bull call spread’s profit increases as the underlying security’s price increases up to the strike price of the short call option. Thereafter, the profit remains stagnant if the underlying security’s price increases beyond the short call’s strike price.
Conversely, the position would have losses as the underlying security’s price falls, but the losses remain stagnant if the underlying security’s price falls below the long call option’s strike price.
$15 Trillion
The daily trading volume of all U.S. options markets, as of Dec. 22, 2023.
How the Bull Put Spread Works
A bull put spread is also called a credit put spread because the trade generates a net credit to the account when it is opened. The option purchased costs less than the option sold.
Since a bull put spread involves writing a put option that has a higher strike price than that of the long call options, the trade typically generates a credit at the start. The investor pays a premium for buying the put option but also gets paid a premium for selling a put option at a higher strike price than that of the one he purchased.
The maximum profit using this strategy is equal to the difference between the amount received from the sold put and the amount paid for the purchased put—the credit between the two, in effect. The maximum loss a trader can incur when using this strategy is equal to the difference between the strike prices minus the net credit received.
Benefits and Disadvantages of Bull Spreads
Bull spreads are not suited for every market condition. They work best in markets where the underlying asset is rising moderately and not making large price jumps.
As mentioned above, the bull call limits its maximum loss to the net premium (debit) paid for the options, it also caps profits up to the strike price of the short option.
The bull put, on the other hand, limits profits to the difference between what the trader paid for the two puts – one sold and one bought. Losses are capped at the difference between strike prices less the total credit received at the creation of the put spread.
By simultaneously selling and buying options of the same asset and expiration but with different strike prices, the trader can reduce the cost of writing the option.
Pros
- Limits losses
- Reduces costs of option-writing
- Works in moderately rising markets
Cons
- Limits gains
- Risk of short-call buyer exercising option (bull call spread)
Calculating Bull Spread Profits and Losses
Both strategies achieve maximum profit if the underlying asset closes at or above the higher strike price. Both strategies result in a maximum loss if the underlying asset closes at or below the lower strike price.
Breakeven, before commissions, in a bull call spread occurs at (lower strike price + net premium paid).
Breakeven, before commissions, in a bull put spread occurs at (upper strike price - net premium received).
Example of a Bull Spread
Let’s say a moderately optimistic trader wants to try doing a bull call spread on the Standard & Poor’s 500 Index (SPX). The Chicago Board Options Exchange (CBOE) offers options on the index.
Assume the S&P 500 is at 4402. The trader purchases one two-month SPX 4400 call for a price of $33.75, and at the same time sells one two-month SPX 4405 call and receives $30.50. The total net debit for the spread is $33.50 - $30.50 = $2.75 x 100 contract multiplier = $275.00.
By purchasing the bull call spread the investor is saying that by the expiration, he anticipates the SPX index to have risen moderately to a level above the break-even point: 4400 strike price + $2.75 (the net debit paid), or an SPX level of 4402.75. The investor’s maximum profit potential is limited: 4405 (higher strike) - 4400 (lower strike) = $5.00 - $2.75 (net debit paid) = $2.25 x $100 multiplier = $225 total.
This profit would be seen no matter how high the SPX index has risen by expiration. The downside risk for the bull call spread purchase is limited entirely to the total $275 premium paid for the spread, no matter how low the SPX index declines.
Before expiration, if the call spread purchase becomes profitable, the investor is free to sell the spread in the marketplace to realize this gain. On the other hand, if the investor’s moderately bullish outlook proves incorrect and the SPX index declines in price, the call spread might be sold to realize a loss less than the maximum.
What Is the Difference Between a Bull Spread and a Bear Spread?
A bull spread is an options trading strategy that predicts a price increase in the underlying security. The trader realizes a profit if the price closes at or above the anticipated price. If the price of the security decreases, the trader’s losses should be limited if the spread is well executed.
What Is the Most Aggressive Type of Bull Spread?
In a bull call spread, the options trader buys a call option for a certain security and sells another call with a higher strike price. The most aggressive bull spreads are those where both calls are initially out-of-the-money because OTM calls tend to be cheaper (and riskier) than in-the-money calls.
Is a Bull Call Spread a Good Strategy?
A well-executed bull spread can provide reliable profits while reducing the trader’s exposure to losses. However, a bull spread is not suitable for every market. This strategy has the biggest advantages if the underlying is moderately trending upwards. If the underlying is increasing in large, sudden jumps, a bull spread strategy could miss out on potential profits.
The Bottom Line
A bull spread is an options trading strategy that allows traders to bet on the price growth of a security. In this strategy, the trader buys a call option at a certain strike price and sells another with the same expiration date but a lower strike price. If the price closes above the strike price, the trader makes money; if not, the trader’s losses are limited to the net cost of the options.
References
- Fidelity. “Bull Call Spread”.
- Chicago Board of Exchanges. “U.S. Options Market Volume Summary”.
