One thing you’ll notice when you start to learn about options and option trading strategies is that there is a lot of them. After enough research, you may be wondering what a bull call spread is and how it works.
The bull call spread is one of the best bullish options strategies. It consists of two call options, and the trade is done for a debit. Let’s dive into how you can take advantage of the bull call spread strategy:
Bull Call Spread — A Directionally Bullish Options Strategy
Here’s a bull call example to give you a better idea of how this method works:
On January 18, 2019, Tesla (NASD: TSLA) shares closed at $302.26. Let’s assume you were bullish and think it can bounce over the next 2-3 weeks.
Now, the $302.50 calls expiring in 32 days are trading for about $2,600 per contract. That’s a lot cheaper than buying 100 shares of Tesla, but it’s still expensive for many investors. That said, to bring down the cost, and maintain a bullish approach, you can sell a call against your long. For example, if you sell the $315 calls (same contract month) you can collect about $1,975. Almost every broker allows you to place this trade as a single order.
What does a bull call spread do? It brings down the cost of your position. For example, the 302.5/315 call spread costs $610. However, it does limit your upside past 315.
The bull call spread gives you more leverage too. For example, for the same cost of buying the $302.50 call, you can buy four $302.50/315 call spreads.
Analyzing and Calculating Break — Even on a Bull Call Spread
In addition to bringing costs down, a bull call spread also gets you closer to breaking even. For example, if you buy the $302.50 call, it will cost you about $26 per share. In other words, in order to break even on the call option, you’d need the stock to be $328.50 ($302.50 + $26) at expiration. On the other hand, if you bought the bull call spread $302.50/315 it would cost you about $6.10. That said, to break even on the call spread, you’d need Tesla shares to be at $308.75 by expiration.
When you buy a bull call spread, your risk is limited to the premium spent. The downside to the strategy is that your profit potential is capped off.
For example, the most that you can make on the $302.50/315 call spread is $12.50. However, since the spread costs $6.10, you subtract that from $12.50 and get $6.40. In this example, you are risking $6.10 to make a maximum of $6.40.
When You Should Pick a Bull Call Spread Over Buying Calls
A bull call spread can be purchased instead of using a call when you believe option premiums are rich. To an options trader, options are rich when implied volatility is relatively high. For example, over the past 52 weeks, Tesla’s 30-day implied volatility has traded between 35.1% and 86.9%. That said, at an IV of 71.5%, Tesla’s options are rich and in the 93rd percentile (last 52 weeks). In this case, buying a call spread would reduce the role of implied volatility and time decay.
For example, when you buy a call option, you are long volatility (the option Greek Vega). That said, when you sell a call option, you are short volatility. By selling the $315 call against the $302 call, you are offsetting the long volatility factor. In other words, one could argue that a bull call spread is more of a pure directional trade than buying outright calls because the role volatility plays. For example, option premium gets juiced ahead of earnings. That said, if you had a bullish bias, trading the call spread would be cheaper and less of a volatile trade then buying a call.
This goes without saying: If you are new to trading options, learning how to trade using spreads is a great transition if you are coming from trading stocks. Why? Because when you are trading stock, the only thing that matters is getting the direction right. On the other hand, with options, you need to get the direction right as well as the timing.
Mistakes People Make When Trading Bull Call Spreads
When you buy a bull call spread, you need to have some width between the call you are long on and the call option you are short on. For example, if you bought the $302.50/$305 in Tesla, that spread would be too tight. What does that mean? Well, the spread would have to get deep in the money or you have to wait to close out the trade as it approaches expiration. The $302.50 and $305 calls are going to move very closely with each other. That means if the stock moves higher, you’ll be making profit on your long call but those gains will be small because of the short call.
On the other hand, you don’t want to sell call options that are too cheap. The purpose of a call spread is to bring your cost down and reduce the role that time and volatility play on the trade. If the options you are looking to sell look relatively cheap, then it’s better to buy the outright call.
Which Strike Prices Should You Select When Buying a Call Spread?
That really depends on what your thoughts on where the stock will go. Options that are closest to at-the-money are the most sensitive to changes in time, volatility, and price. Buying in-the-money-options and selling at-the-money calls makes the trade more sensitive to price changes in the stock.
If you buy the $290 call, it will cost you around $33 in option premiums. If you sell the $305 call for $24.50, the total cost of this spread is $8.50. However, the spread has $12 of intrinsic value, because the stock is trading at $302.26. You take $302.26 and subtract it by $290 to get $12.26. The maximum profit potential on this trade is $6.50 ($15 – $8.50). That said, if the stock doesn’t move lower or trade higher, this position would be a winner.
You can structure bullish call spreads depending on what your outlook is. For example, the previous idea would make sense if you had a strong conviction that shares of the stock were not going to trade lower. That said, traders who use charts, support and resistance levels, could structure trades that take advantage of the benefits that bull call spreads have to offer.
The bull call spread is a good idea when option volatility is high and you want to make a bullish play on a stock or ETF. The downside is that your profit potential is capped off. However, it does reduce the costs and give you the chance to use more leverage. It goes without saying, this strategy is great if you are trading high-priced stocks like Amazon, Alphabet, Tesla, and others.
Adding the bull call spread to your trading arsenal is a great idea if you know how to use it properly. The bull call spread method is just another tool at your disposal. Be sure you study examples of bull call spreads to see what works and what doesn’t. Whether you’re looking to diversify your investments and returns, or you need to take your trading game to the next level, the bull call spread is great way to manage risk and boost profit.