If you’re interested in options trading, you may have heard of a bull spread. This is a type of spread trade where you buy a call option with a lower strike price and simultaneously sell a call option with a higher strike price. The idea behind this trade is that you want the underlying asset to increase in price, but only up to a certain level. In this blog post, we’ll take a closer look at bull spreads and provide an example of how you can make a profit from them.
What is a Bull Spread?
A bull spread is a type of options trading strategy that involves buying a call option with a lower strike price and selling a call option with a higher strike price. The two options should have the same expiration date and the same underlying asset. The call option with the lower strike price is known as the long call, and the call option with the higher strike price is known as the short call.
The profit potential of a bull spread is limited, but so is the potential loss. The maximum profit is the difference between the strike prices minus the cost of the options. The maximum loss is the cost of the options.
Example of a Bull Spread Profit
Let’s say you’re bullish on ABC stock, which is currently trading at $50. You decide to enter into a bull spread by buying a call option with a strike price of $45 for $3 and selling a call option with a strike price of $55 for $1.50. This trade will cost you a net debit of $1.50 per share ($3 for the long call minus $1.50 for the short call).
If the stock price of ABC increases to $60 by expiration, your long call will be worth $15 ($60 – $45), and your short call will be worthless. You’ll make a profit of $13.50 per share ($15 from the long call minus $1.50 for the net debit).
If the stock price of ABC increases to $70 by expiration, your long call will be worth $25 ($70 – $45), and your short call will be worth $15 ($70 – $55). You’ll make a profit of $8.50 per share ($25 from the long call minus $15 from the short call minus $1.50 for the net debit).
If the stock price of ABC increases to $80 by expiration, your long call will be worth $35 ($80 – $45), and your short call will be worth $25 ($80 – $55). You’ll make a profit of $8.50 per share ($35 from the long call minus $25 from the short call minus $1.50 for the net debit).
If the stock price of ABC does not increase above $55 by expiration, both your long call and your short call will expire worthless, and you’ll lose the entire net debit of $1.50 per share.
Conclusion
Bull spreads can be a useful options trading strategy for investors who are bullish on a stock but want to limit their risk. By buying a call option with a lower strike price and selling a call option with a higher strike price, investors can profit from a stock’s increase in price up to a certain level. However, it’s important to note that the potential profit of a bull spread is limited, as is the potential loss. It’s always important to do your own research and consult with a financial advisor before entering into any options trading strategy.