Bull Call Spread Strategy Explained

In the derivatives market, traders use option strategies to manage risk and earn profits. They apply these strategies when they understand price movements. One such method is the spread strategy. It involves choosing positions from the option chain and is easy to implement.

Many traders prefer the bull call spread strategy. It helps them limit losses while trading call options. They value it for its simple structure and ease of use.

If you are new to the world of options, especially if you are managing your own investments, it is important to know the foundational concepts of spread trading.

To understand this spread strategy, it is important to first explore the basic elements of options and what a ‘spread’ position means in this context:

A bull call spread consists of buying a call option with a lower strike price while, at the same time, selling a call option with a higher strike price. Both options rely on the same underlying asset and have the same expiry date.

Traders call this strategy ‘bullish’ because it aims to profit when the price of the underlying asset rises moderately. The term ‘spread’ refers to the difference between the two strike prices. Traders pay more for the lower strike call than they receive from the higher one, creating a net debit.

Core components of bull spread option strategy:

• Long Call (Lower Strike Price): Purchased for a premium, representing the right to buy the underlying at a lower price

• Short Call (Higher Strike Price): Sold to reduce the net premium paid, limiting potential profit
  

This structure offers limited risk and limited reward, making it a defined-risk strategy preferred by investors with a conservative bullish outlook.

This strategy works best in a bullish market with limited upside potential. Traders adjust the strike prices based on their risk appetite and market view:

• Wider spreads between strike prices increase potential profit but also raise the breakeven point

• Narrower spreads reduce both cost and risk

This strategy suits traders who:

• Expect a moderate rise in the stock price

• Want to lower the cost of buying a call option

• Are comfortable limiting their gains in exchange for reduced risk

It offers defined risk and defined reward, making it ideal for disciplined traders who prioritise risk control over unlimited returns.

The bull call spread aims to capture the premium difference between two call options. 

When the underlying asset’s price rises above the strike price of the long call, the gain from the long call offsets the loss from the short call. However, the profit remains limited to the difference between the strike prices.

Since traders pay more for the long call than they receive from the short call, the strategy begins with a net debit.

To set up a bull call spread:

• Buy one at-the-money (ATM) call option

• Sell one out-of-the-money (OTM) call option

Note: Use the same underlying asset, expiry date, and quantity for both contracts.

Key Calculations

• Calculate the Net Premium Outlay by subtracting the premium received from the short call from the premium paid for the long call

  • Formula: Net Premium Outlay = Premium (Long Call) – Premium (Short Call)

• Determine the Maximum Loss by adding any commissions to the net premium outlay

  • Formula: Maximum Loss = Net Premium Outlay + Commissions

• Find the Maximum Gain by subtracting the total cost (net premium outlay and commissions) from the difference between the two strike prices

  • Formula: Maximum Gain = (Strike Price Difference) – (Net Premium Outlay + Commissions)

• Identify the Breakeven Point by adding the net premium outlay to the strike price of the long call

  • Formula: Breakeven = Strike Price of Long Call + Net Premium Outlay

Examples of Bull Call Spread

Let’s say the stock ABC is trading at ₹50. You expect it to rise to ₹60, so you set up a Bull Call Spread with a lot size of 100 shares.

Here’s how you set it up:

• Buy one ABC ₹50 Call Option at ₹3 (₹3 × 100 = ₹300)

• Sell one ABC ₹55 Call Option at ₹1 (₹1 × 100 = ₹100)

Net cost = ₹300 – ₹100 = ₹200

Scenario 1: Stock rises to ₹60 at expiry

• The ₹50 Call becomes worth ₹10 (₹60 – ₹50) → ₹10 × 100 = ₹1,000

• The ₹55 Call becomes worth ₹5 (₹60 – ₹55) → ₹5 × 100 = ₹500 (you pay this as the seller)

Net profit = ₹1,000 – ₹500 – ₹200 = ₹300

Scenario 2: Stock stays below ₹50

• Both options expire worthless
  You lose only the ₹200 you paid initially

• This is your maximum loss in this strategy

You can generally use this strategy when you expect a moderate rise in the underlying asset's price but wish to limit risk exposure. Some common scenarios where the bull call spread might be perfect:

• When the market outlook is mildly bullish, but you do not expect a strong surge in price

• When you prefer a limited-risk strategy that is more cost-effective than buying a single-call option

• When implied volatility is stable or slightly low, making premiums relatively reasonable
  

Note: Since this strategy caps both profits and losses, it is not suitable for highly bullish or volatile expectations. 

The bull call spread and bull put spread are both bullish strategies; however, they vary notably in terms of their structure, margin requirements, and potential outcomes.

Below is a comparison that outlines how they operate under similar market views but with different trade-offs:

The bull call spread is often considered more accessible due to its lower capital and no-margin requirement. The bull put spread can offer credit income but with a higher level of capital commitment.

Every strategy has its strengths and limitations, and understanding both helps in responsible strategy selection:

• Benefits

  • Defined Risk: You can only lose the net premium you paid for

  • Cost Effective: Compared to buying a call outright, the short call helps reduce the initial investment

  • Predictable Outcome: As you are aware of both maximum gain and loss, it is easier to plan capital usage
    

• Limitations

  • Capped Upside: Even if the market moves significantly upward, the profit limits its spread between the strike prices minus the net premium

  • Time Sensitive: The long call component loses value as expiry approaches, particularly if the underlying doesn’t move

  • Requires Correct View: The strategy is ineffective in sideways or bearish markets

In certain situations, traders might want to modify their bull call spread to respond to market changes or protect capital. Common adjustments include:

• Rolling Up: Close the current spread and open a new one with higher strike prices if the market is more bullish than anticipated

• Rolling Down: If the market drops, shifting both strike prices lower can reduce the potential loss or adjust the breakeven

• Close Early: You can exit the position to secure partial profits or minimise losses if your outlook changes 

Adjustments involve transaction costs and fresh premiums, so you must evaluate them carefully.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

The bull call spread is a strategic approach within the options trading landscape for scenarios where you can expect moderate price gain. With its defined risk and reward structure, it provides an opportunity to gain exposure to bullish movements while keeping capital and loss parameters in check. 

If you are exploring options strategies for cost-efficiency and clarity, the bull call spread will offer a balanced entry point into the world of spread trading.