What is a Bull Call Spread?

A bull call spread strategy is an Options trading strategy that uses two Call Options with different strike prices to create a range. The expiration date and underlying asset, however, are the same for both Options. This strategy limits the loss but also caps the gains. In simple terms, a bull call spread is used when the investor believes that the stock will have a limited increase in price.

Before deep-diving into the bull call spread strategy, here are a few terms that will help you:

Long Call:

When an investor buys a Call Option, it is known as a long call. The investor can choose to exercise their right to buy at the strike price at the expiration date.

Short Call:

When an investor sells a Call Option, it is known as a short call. The investor is obliged to sell at the strike price at expiration if the Call Option is in the money on the expiration date.

how the bull call spread works.

Suppose Disha is a bullish investor and expects the market price of stock X to increase slightly. Stock X is currently trading at ₹1000. To create a bull call spread, Disha will buy a Call Option with a strike price of ₹1,300 for a premium of ₹100. At the same time, she sells a Call Option for ₹1,200 for a premium of ₹150.

A bull call spread involves investor debt. In this trade, Disha has paid more premium for a lower strike price and received less premium for a higher strike price. Thus, the net difference between these premiums is the cost of the strategy. Since every Option consists of 100 shares, Disha has paid ₹5000 [(₹150 - ₹100) x 100] as the cost of this strategy.

Market Price Long/Short Call Strike Price Premium Total premium (Premium x 100)
₹1,000 Long ₹1,200 ₹150 ₹15,000
₹1,000 Short ₹1,300 ₹100 ₹10,000

As a bullish investor, a favorable condition for Disha is if the market price increases. Three scenarios may arise on the expiration date.

    • The market price is lower than ₹1,200

      If the market price remains lower than ₹1,200, both the long Call and short Call will not be exercised as they yield no profit to their respective buyers. Thus, Disha does not earn at all and her total loss is the net difference between the premiums i.e. ₹5000. The maximum loss that can be incurred in a bull call spread is the net difference between the premiums of short Calls and Long Calls.

    • The market price is between ₹1,200 and ₹1,300

      Let us assume that the market price of stock X on the expiration date is ₹1,260. In this case, the only Call Option that is in the money is the long call. By exercising her right to buy at ₹1,200, Disha makes a profit of ₹60/share. Her profit from the long Call is ₹6,000. However, her net profit will be ₹1,000 as she had already paid ₹5,000 as the net difference.

      The break-even point would be achieved when the market price is at ₹1,250. Disha earns ₹50 by exercising the long call. However, she has paid ₹50 per share as a net premium. Therefore, she is at a no-profit no-loss, or break-even position.

    • The market price is above ₹1,300

      When the market price of stock X goes above the higher strike price i.e. short call, both the Call Options are in the money. Disha has to sell at ₹1,300 to the buyer of the short call. However, she can buy the stock at ₹1,200 as she can exercise her long call. Thus, her profit at expiration will be ₹10,000 (₹100/share). Now, the net premium paid will be deducted from this amount to arrive at a net profit. The formula for maximum profit in a bull call spread strategy is [(Higher Strike Price - Lower Strike Price) - Net Premium] x 100

Benefits of Bull Call Spread Strategy

  • Low cost

    Buying a Call Option is more expensive than using a bull call spread strategy. This is because the investor also sells a Call Option simultaneously. The net premium is lesser than the cost of just buying a Call Option. Therefore, it is beneficial to traders with a low investment appetite.

  • Limited Maximum Loss

    In the absence of a bull call spread, the investor may have to suffer unlimited losses if the market moves unfavorably. In a bull call spread, the maximum loss is the difference in the premium of the long and short Call Options.

Who should use the bull call spread strategy?

A bull call spread strategy is useful when the investor expects a slight price increase. Since most stocks increase in smaller amounts, in theory the bull Call spread looks like the more attractive strategy as it has a higher chance of yielding profits than buying a Call Option. However, practically it is a subjective decision. A bull call spread strategy is the choice when the market price is forecasted to increase to just below or at the strike price of the short call.

Frequently Asked Questions Expand All

The maximum loss in a Bull Call Spread is calculated as (Premium Paid - Premium Received) x 100.

The maximum profit is achieved when the market price goes above or is at the higher strike price. It is calculated as

[(Short Call Strike Price - Long Call Strike Price) - Net Premium] x 100

A breakeven point is achieved when the market price is above the long Call strike price by the same amount as the net premium. A break-even point is when

Market Price - Long Call Strike Price = Net Premium Paid

A bull call spread requires a lower investment than just buying a Call Option. It also limits the risk that can be incurred if the market price of the stock does not increase as expected. It is a fairly easy strategy to understand and execute.