How to Use the Bull Call Spread to Reduce Risk and Increase Profitability


How to Use the Bull Call Spread to Reduce Risk and Increase Profitability

The Bull Call Spread is one of the best options trading strategies.

Options traders can use this strategy to take advantage of stock price movement with very little capital risk.

Bull call spreads are ideal for traders with a smaller account size, and scalable for traders with larger balances also.

 

What is the Bull Call Spread?

The bull call spread options trade is a directional trade.  Traders profit from seeing the stock price advance in their expected direction.

Furthermore, this options strategy is a debit spread, as it takes away from your account balance and buying power.

There are two different options “legs” (positions) combined into one spread.

Formula: Bull Call Spread = Long Call Option + Short Out-of-the-Money (OTM) Call Option.

One of the biggest benefits of this bull call spread options strategy is that your losses are limited and known before the trade is executed.

Also, your profits are also limited in an exchange.

Here is a diagram to help you visualize the bull call spread profit and loss diagram.

Bull Call Spread Profit Loss Diagram

Let’s take a look at a real time example to explain the idea of the bull call spread option strategy.

 

When to Use the Bull Call Spread Options Strategy

The bull call spread is a great play for traders who are moderately directional, but not outright convinced it will continue.

If you are expecting to see a stock increase by $10, but don’t expect it to go much higher than that – this is the perfect strategy.

Because you are giving up the option of making more money if it goes your way, you get the benefit of paying much less to open this trade.

When would you expect a stock or commodity to stop moving?

A strong resistance level is a good target area, and thus it can become a good profit target area.

For example:

A trader believes that Bank of America (BAC) will hold the support level at $30.  Also, the price is expected to go up to the $32.50 to $33.00 resistance area, but likely not much higher.

Now let’s get into building a bull call spread options trade to take advantage of this opportunity.

BAC Bull Call Spread Trade Idea

BAC Bull Call Spread Trade Idea

 

 

Bull Call Spread Options Strategy Setup

First we choose the two levels we want to use to build the bull call spread.

The $30 is going to be our support, and $33 will be the target at resistance.

In order to execute the bull call spread you need to:

  1. Buy the May 18th, $30 strike call option on BAC – paying $97 per contract
  2. Sell the May 18th, $33 strike call option on BAC – receiving $9 per contract
  3. Net total = $97 paid – $9 received = $90 average cost (debit amount)

This is what the order looks like on the Interactive Brokers trading platform that we use for options trading.

 

And now we can have a look at the trade probability statistics.

  • Return to risk is 2.37 , meaning you are making $2.37 per $1 of risk – a great ratio
  • Maximum return is $211 (more on this in next section)
  • Maximum loss is $89 (more on this in next section)
  • Right chart shows the profit loss diagram of this bull call spread as prices move along the x scale (profit on Y)

 

 

 

Bull Call Spread Options Strategy – Maximum Risk and Maximum Return Explained

The maximum return in the bull call spread is achieved when the stock price trades at, or above the short call strike price.

This occurs because you sold a call option above that price, giving up the benefit of more appreciation in exchange for the $9 of premium you received.

Net of what you received, you were able to reduce your trade cost by 10% ($9/$90 total).

But what is the total profit?

The call strike we own is $30, and the call we sold above was at $33.  The difference is your total profit, or $3 per contract.  Multiplied by 100 shares, it is a total of $300.

But you paid $90 to purchase this bull call spread.

Once you subtract the cost of the trade from the profit, your total is $210.  ($300 – $90)

That is approximately a $2.37 gain for every $1 you risked – an amazing money management ratio.

In addition, your maximum risk on the bull call spread will never exceed what you paid for it, which was $90 in our example.

 

Bull Call Spread Options Strategy – Conclusion

The bull call spread options strategy is great because it allows you to reduce your cost base, which reduces your loss potential.

Also, it allows you to keep most of the upside potential up to a certain level.

In our options trading course, part of the Swing Trader subscription we teach you how to structure this trade like professional options traders.

I will show you how to use this strategy to generate highly probably trade setups.

You will also learn when to use the strategy, and when it’s best to be left on the shelf.

Sign up now and get instant access as part of our Swing Trader subscription.

 

Thank you.

Good luck and good trading.

 

 

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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.