What is a Bull Call Spread strategy?
What is a Bull Call Spread? It’s a strategy, a way of making small, yet reliable gains in options trading. Admittedly, it’s an advanced technique, even for the options market. It takes a total understanding of the option pricing, as well as good management of your resources. Only with all of that you can make use of this strategy.
It’s used if the investor believes a stock will moderately rise in value over some time. Since buying a call option to buy these stocks later at a slightly higher market value could be pricy, this strategy dictates that you sell a call option for an even higher price. Gains from selling it will offset the costs of buying the option in the first place.
How does it even work?
If you got confused by all these options rules, you need to remember several things before we proceed:
- Call options are options that allow you to buy stock later (before the expiration date) and a set price (called the strike price), but you don’t have to do it.
- This strategy is aimed at moderate rather than big gains, hence the risk management.
- Buying options costs money, including premium and net cost per contract, while selling them gives money to you, although at a smaller rate because your option is set for a higher price (that’s just how it works).
So, the whole picture of the Bull Call Spread is that a lot of people look at the promising stock and attempt to buy a call option (a purchase option) for it at a high price. They do it because it costs less money to buy this option. Their logic is that this stock can very well increase its value multiple times over.
Their wish is that this stock becomes more valuable than the strike price set on their option. That means they can buy stock and then immediately sell it for more (or wait for it to grow even more in value).
If the premium is small (and it is small for big price growths such as this), then it’s easy to pay it back with your gains. If the price falls short of what they expect, they can just let the option expire. Sure, it’ll cost money, but that’s the price you pay for risks.
The Bull Call Spread Strategy, by comparison, is supposed to be less risky at the expense of fewer profits.
Strategy in Action
So, now that you know why it’s allowed to happen, let’s see how it usually happens. There are three simple steps in this plan:
- Find a stock that you believe will rise in value soon enough
- Buy a call option for some small value growth by some expiration date
- At the same time, sell an option for this same stock and for the same expiration date, but higher price.
You won’t redeem that second option because you just sold it to someone; it’s there for two purposes. Purpose one: OFFSET RISKS – people pay you to basically rent your option, and you’ll use this money to pay your own rent. Purpose two: SALE OF YOUR BOUGHT SHARES.
The second part needs more explaining because this topic can be excruciatingly confusing. See, if you sell the option to someone, you give them a right to buy your shares later. But you have to have shares, first. Where do you get them? Well, from your own option, of course.
The whole idea is that you buy your stock at a smaller price with your own contract and then immediately sell them to whoever bought your option because they decided to redeem their own contract. At that point, you have guaranteed gains. Even if your friend doesn’t buy your shares, his contract will expire and you can sell them manually.
The only challenge here is that you also need to offset the premium and net cost you paid for your option with your gains and be left with something of value. Normally, the investors receive gains, but this strategy isn’t called a low-risk low-profit strategy for nothing. It’s just a sure way of getting money risk-free (almost risk-free).
The only substantial losses you can suffer here happen if the actual price of the stock falls short of the price you have in your bought call option, which means it expires and you still have to pay money. The money from your sold call option will manage the risks somewhat, but you’ll still lose some.
Calculating your own approach
Naturally, you can pick any price you want both for the first and second options, which is rather thrilling. However, different options have different costs, depending on how distant your strike price is from the current market price, the value of underlying assets, as well as many more parameters.
There are many more things that determine just how much you’re going to pay, how much you can gain, and how much of that will be spent to offset the risks. Even more so, considering they change over time.
It’s mind-boggling and if you had to calculate all of that in your head, you’d likely go insane. Luckily, there’s a thing called a Bull Call Spread Calculator, which will calculate all of that.
Basically, find a Ball Call Spread Calculator online, enter some prices that seem like a good idea to you and see where they’ll take you. If your results show that you can afford the risks and that the profits you’ll receive in the end are good enough, then you’re clear to go.
Just make sure you know exactly how the call options work before starting.
Pros and Cons
Now that you know what a Bull Call Spread is, let’s just sum both the advantages and the disadvantages of this strategy.
- Small risks. The costs you have to pay for your option are partially offset by the option you sold. The rest can be paid off using the gains you acquired.
- Certain profits. While you can’t say this strategy earns a lot, you can definitely say that it earns reliably.
- Small cost. Buying call options this way is generally cheaper than doing it with just one call option and using it normally.
In short, you can make use of a bullish trend by simply buying one option and selling the other to offset the costs. Even if your plan doesn’t work out, your losses are limited by the money you receive from selling the other option.
- Limited profits. It’s an obvious downside, and if you want to earn a lot in one go, this strategy is likely not going to work out for you.
- Difficulty. Not only do you need to understand how the profits work to manage your costs properly, but you also need to find someone willing to buy your option at precisely the price you want, which can be rather hard.
A good call would be to launch several of these strategies at once, using various selling prices for your options. But that also requires precision, management, and attention. That’s exactly why this strategy is not recommended for beginner traders.Yes, I want access to free training