Bull Call Spread: Strategies, Examples, Advantages And Risks

Among the various strategies available in the derivatives market, spread strategies are often used by participants who prefer the potential for defined outcomes instead of open-ended exposure. One such approach is the bull call spread, which may be considered when there is a moderately bullish view on the price movement of an underlying asset.

This article explains the bull call spread, including how it works, when it may be considered, how potential profits and losses are structured, and how it compares with other commonly used options strategies.

Table of contents

• What is a bull call spread?
• When to use a bull call spread
• How a bull call spread works: Building the strategy
• Bull call spread example and profit/loss dynamics
• Key factors affecting bull call spreads
• Advantages of using a bull call spread
• Bull call spread vs. other options strategies
• Options trading vs. long-term mutual fund investing

What is a bull call spread?

A bull call spread is an options trading strategy involving two call options on the same underlying asset and the same expiry date. In this structure, a market participant buys a call option at one strike price and simultaneously sells another call option at a higher strike price in equal quantity.

This strategy may be considered when the participant expects the price of the underlying asset to rise over time, but not sharply beyond a certain level.

When to use a bull call spread

A bull call spread may be considered when a participant expects a gradual upward movement in the price of an underlying asset rather than a sharp rise. Situations where this approach may be evaluated include:

• Moderately bullish outlook: There may be an expectation of a potential price increase without high volatility.
• Relatively moderate price movement: The strategy may be evaluated when prices are expected to remain within a defined range.
• Lower initial premium outlay: Compared to buying a single call option, the structure may reduce the net premium paid due to the premium received from the sold call option.

Also Read: Option Chain Guide: Meaning, How It Works & How to Read

How a bull call spread works: Building the strategy

Long call

A long call position involves buying a call option with the expectation that the underlying asset’s price may rise. In a bull call spread, the long call is typically exposed to time decay. As time passes, the option’s value may decline if the underlying price does not move favourably. If the price remains near or below the lower strike price until expiry, the value of the long call may erode due to time decay.

Short call

A short call position involves selling a call option, generally with the expectation that the underlying price may remain below the strike price until expiry. In a bull call spread, the impact of time decay is mixed. If the underlying price stays between the two strike prices, the short call may lose value at a faster rate than the long call. If the price moves well above the higher strike price, both options may respond similarly to price movements, and the relative impact of time decay may reduce.

Reducing net debit with a spread

A bull call spread typically involves buying a lower strike call option and selling a higher strike call option. In many cases, the lower strike option may be in-the-money (ITM) and the higher strike option may be out-of-the-money (OTM), although this is not mandatory. The premium received from selling the higher strike call may partially offset the premium paid for the lower strike call, thereby reducing the net premium outlay.

An ITM call option has intrinsic value when the market price of the underlying asset is above the strike price. An OTM call option has no intrinsic value and derives value from the potential for future price movement.

Also Read: Equal Weighted Index Funds: Meaning, Formula & Benefits

Bull call spread example and profit/loss dynamics

Rohan considers a bull call spread strategy on ABC Ltd, which is trading at Rs. 150 per share. He buys a call option with a strike price of Rs. 145 by paying a premium of Rs. 10. This option expires in January. Simultaneously, he sells a call option with a strike price of Rs. 180 and receives a premium of Rs. 2, with the same expiry date.

The net premium paid for the strategy is Rs. 8 (Rs. 10 paid minus Rs. 2 received).

Using standard bull call spread calculations, Rohan finds:

• Maximum profit: Rs. 180 – Rs. 145 – Rs. 8 = Rs. 27
• Maximum loss: Rs. 8 (limited to the net premium paid)
• Break-even point: Rs. 145 + Rs. 8 = Rs. 153

Example for illustrative purposes only.

This example illustrates how a bull call spread defines both potential gains and potential losses, depending on the underlying price movement at expiry.

Maximum potential gain calculation

The maximum potential gain is calculated as the difference between the two strike prices minus the net premium paid.

Maximum gain (per share) = (Out of the Money Strike Price - In the Money Strike Price) - Net Premium

Maximum potential loss calculation

The maximum loss is the net premium paid for the options.

Maximum loss = Net premium paid (premium paid for the long call − premium received from the short call)

Breakeven point at expiration

The breakeven price is the market price an asset needs to reach for the spread to return the money spent.

Breakeven = In the Money Strike Price + Net Premium

Key factors affecting bull call spreads

Volatility’s impact on the strategy

In a bull call spread, the impact of changes in volatility may be relatively reduced because both a call option is bought and another is sold on the same underlying asset with the same expiry. An increase in volatility may raise the value of both options, which may partially offset each other.

Time decay (Theta) and its role

Time decay, also referred to as theta, affects both legs of a bull call spread differently. The long call may lose value as expiration approaches, while the short call may also experience time decay. The net effect of time decay may depend on where the underlying asset trades relative to the strike prices as expiry approaches.

Advantages of using a bull call spread

• Relatively lower initial premium outlay compared to a single long call
• Defined maximum potential loss
• Lower breakeven level compared to buying a call option outright
• Potentially reduced net impact of time decay compared to a standalone long call position

Bull call spread vs. other options strategies

Compared with other strategies, a bull call spread may involve a lower initial premium than a long call while defining both potential gains and losses. Long call positions may aim to benefit from sharp upward movements, covered calls may be used to generate potential income, bull put spreads may benefit from time decay, while buying shares directly may require higher capital and exposes the investor to the full downside risk.

Options trading vs. long-term mutual fund investing

Options trading is generally used for short- to medium-term market views and may involve strategies designed to benefit from price movements, volatility, or time decay. Outcomes in options trading are typically influenced by multiple factors, including the direction of the underlying asset, time remaining until expiry, and changes in volatility.

In contrast, long-term mutual fund investing focuses on potentially building wealth over extended periods through exposure to diversified portfolios of securities. Equity mutual funds, in particular, aim to participate in the long-term growth potential of businesses and the economy, with returns influenced by factors such as earnings growth, economic cycles, and compounding over time.

FAQ

What is the main difference between buying a single call option and a bull call spread?

Buying a single call option may offer uncapped upside in theory, subject to favourable price movement in the underlying asset. A bull call spread may reduce the net premium paid while placing a defined limit on potential gains.

Are bull call spreads suitable for beginners in options trading?

The strategy has a defined risk structure, which may make it easier to analyse compared to some complex strategies. However, it still involves derivatives risk, and participants are advised to understand the mechanics thoroughly.

What happens if the stock price moves sharply beyond the higher strike price?

If the price moves above the higher strike price, the potential gain remains capped at the maximum level defined by the spread structure.

Can I close out a bull call spread position before expiration?

Yes, the position may be closed before expiry by exiting both option legs in the market.

What are the tax implications of profiting from a bull call spread in India?

Gains from options trading are generally treated as non-speculative business income and are taxed accordingly.