Option spread strategies use combinations of options contracts to achieve a particular profit potential vs. cost scenario. The name of a spread is often a description of what the strategy is designed to accomplish. A bull call spread uses call options to profit from the price change of a stock about which you are bullish; you expect the stock to go up.
The Bull Call Spread
A bull call spread consists of two legs or different option contracts. One leg is the purchase of call options with a strike price at or below the current price of the underlying stock. The second leg is the sale of the same number of calls with a higher strike price. Both legs have the same expiration date. The spread will reach its maximum profit potential if the stock price moves above the higher strike price before the expiration date.
Selling the higher strike call option in a bull call spread reduces the cost to set up a bullish trade compared to the outright purchase of a call option. This means the trade turns profitable with a smaller price gain from the underlying stock. The spread also caps the maximum profit, which is not limited with a straight call purchase. The maximum profit is the difference between the strike prices minus the cost to establish the bull call spread. The maximum possible loss is the cost to establish the spread.
Placing the Trade
Enter a bull call spread by placing a simultaneous order for the two legs. Select the two call options from the stock's options chain screen on your online brokerage account. Then use the options strategy menu on the screen to select bull call spread, which should take you to an option trade screen with the information and current prices of the two options already listed. Enter the number of contracts of each leg to trade and the net price you want to pay. For example, the lower strike call is priced at $2 and the $5 higher strike call is quoted at $0.30. The price of the spread would be $1.70. The cost is 100 times the price times the number of contracts in each leg. If your spread is for five contracts of each leg, the cost would be $850 plus commissions.
Managing the Trade
If the underlying stock price moves above the higher strike price, close the trade by selling the lower strike price options and buying back the higher strike contracts. Your brokerage account will let you enter the closing actions as a single trade, reversing the opening trade. As long as the stock stays above the lower strike price, the spread will retain some value. Close the trade before the options expire to retain that value for your account.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.