Order Entry: Net Debit
Ideal Environment: Low IV
Profit Target: 50%
Definition: A bullish call spread consists of simultaneously buying an ITM call while selling an OTM call. The net premium paid is the result of buying the more expensive ITM call and selling the less expensive OTM call. The trade results in a bearish debit position. When entering the trade, the max profit and max loss are known.
Bullish Call Spread Setup
Sell 1 OTM Call
Buy 1 ITM Call
When the stock price rises above the strike price of the short call at the expiration date. Both of the options in the spread will be ITM. The long call will have more intrinsic value than the short call. Max profit is achieved when the underlying stock price is above the short call strike price.
Max Profit= Distance between Call Strikes - Premium Paid (Debit) - Commissions
To calculate the breakeven stock price for the trade, use the following formula:
Breakeven Stock Price = Long Call (Strike Price) + Premium Paid (Debit)
If the stock price rises above the long put strike price at the expiration date, the trade undergoes a max loss.
Max Loss = Premium Paid (Debit) + Commissions
Suppose stock ABC is trading at $19 in April. An options trader bullish on ABC decides to enter a bull call spread position by selling a MAY 20 call for $125 and buying a MAY 18 call for $220 at the same time, resulting in a net debit of $95 for entering this position.
The price of ABC stock subsequently rises to $23 at expiration. Both puts expire in-the-money with the MAY 18 call bought having $500 in intrinsic value and the MAY 20 call sold having $300 in intrinsic value. The spread would then have a net value of $200 (the difference in strike price). Deducting the debit taken when he placed the trade, his net profit is $105. This is also his maximum possible profit.
If the stock had fell to $16 instead, both options expire worthless, and the options trader loses the entire debit of $95 taken to enter the trade. This is also the maximum possible loss.
When to use a bullish call spread strategy?
At Tradezy, we recommend to use this strategy for stocks with a low implied volatility. The trader should have a short to intermediate bullish thesis. We look to buy the spread position that has around 45 DTE with a 50% probability of profit. The goal is to sell this spread back for 50% of max profit.