BULL CALL SPREAD STRATEGY: BUY CALL OPTION, SELL
CALL OPTION
A
bull call spread is constructed by buying an in-the-money (ITM) call option,
and selling
another
out-of-the-money (OTM) call option. Often the call with the lower strike price
will
be
in-the-money while the Call with the higher strike price is out-of-the-money.
Both calls
must
have the same underlying security and expiration month.
The
net effect of the strategy is to bring down the cost and breakeven on a Buy
Call (Long
Call)
Strategy. This strategy is
exercised when investor is moderately bullish to bullish,
because
the investor will make a profit only when the stock price / index rises. If the
stock
price
falls to the lower (bought) strike, the investor makes the maximum loss (cost
of the
trade)
and if the stock price rises to the higher (sold) strike, the investor makes
the
maximum
profit. Let us try and understand this with an example.
When to Use: Investor is moderately bullish.
Risk: Limited
to any initial premium paid in establishing the position. Maximum loss
occurs where the underlying falls to the level of the lower strike or below.
Reward: Limited
to the difference between the two strikes minus net premium cost .
Maximum profit occurs where the underlying rises to the level of the higher
strike or above
Break-Even-Point (BEP):
Strike Price of Purchased call + Net Debit Paid
Example:
Mr. XYZ buys a Nifty Call with a Strike price Rs.
4100 at a premium of Rs. 170.45 and he sells a Nifty Call option with a strike
price Rs. 4400 at a premium of Rs. 35.40. The net debit here is Rs. 135.05
which is also his maximum loss.
Strategy : Buy a Call with a lower strike (ITM) +
Sell a Call with a higher strike (OTM)
|
Nifty index
|
Current Value
|
4191.10
|
|
|
|
|
|
Buy ITM Call
|
Strike Price (Rs.)
|
4100
|
|
Option
|
|
|
|
|
|
|
|
Mr. XYZ Pays
|
Premium (Rs.)
|
170.45
|
|
|
|
|
|
Sell OTM Call
|
Strike Price (Rs.)
|
4400
|
|
Option
|
|
|
|
|
|
|
|
Mr. XYZ
|
Premium (Rs.)
|
35.40
|
|
Receives
|
|
|
|
|
Net Premium Paid
|
135.05
|
|
|
(Rs.)
|
|
|
|
|
|
|
|
Break Even Point
|
4235.05
|
|
|
(Rs.)
|
|
|
|
|
|
The
payoff schedule :|
On expiry
|
Net Payoff from Call
|
Net Payoff from
|
Net Payoff
|
|
Nifty Closes
|
Buy (Rs.)
|
Call Sold (Rs.)
|
(Rs.)
|
|
at
|
|
|
|
|
3500.00
|
-170.45
|
35.40
|
-135.05
|
|
3600.00
|
-170.45
|
35.40
|
-135.05
|
|
3700.00
|
-170.45
|
35.40
|
-135.05
|
|
3800.00
|
-170.45
|
35.40
|
-135.05
|
|
3900.00
|
-170.45
|
35.40
|
-135.05
|
|
4000.00
|
-170.45
|
35.40
|
-135.05
|
|
4100.00
|
-170.45
|
35.40
|
-135.05
|
|
4200.00
|
-70.45
|
35.40
|
-35.05
|
|
4235.05
|
-35.40
|
35.40
|
0
|
|
4300.00
|
29.55
|
35.40
|
64.95
|
|
4400.00
|
129.55
|
35.40
|
164.95
|
|
4500.00
|
229.55
|
-64.60
|
164.95
|
|
4600.00
|
329.55
|
-164.60
|
164.95
|
|
4700.00
|
429.55
|
-264.60
|
164.95
|
|
4800.00
|
529.55
|
-364.60
|
164.95
|
|
4900.00
|
629.55
|
-464.60
|
164.95
|
|
5000.00
|
729.55
|
-564.60
|
164.95
|
|
5100.00
|
829. 55
|
-664.60
|
164.95
|
|
5200.00
|
929.55
|
-764.60
|
164.95
|
The Bull Call Spread Strategy has brought the
breakeven point down (if only the Rs. 4100 strike price Call was purchased the
breakeven point would have been Rs. 4270.45), reduced the cost of the trade (if
only the Rs. 4100 strike price Call was purchased the cost of the trade would
have been Rs. 170.45), reduced the loss on the trade (if only the Rs. 4150
strike price Call was purchased the loss would have been Rs. 170.45 i.e. the
premium of the Call purchased). However, the strategy also has limited gains
and is therefore ideal when markets are moderately bullish.
The
payoff chart (Bull Call Spread)
+ =
Buy lower strike Call Sell OTM Call Bull Call Spread
