Bull Spread

What Is a Bull Spread?

A bull spread is an optimistic options strategy designed to profit from a moderate rise in the price of a security or asset. A variety of vertical spread, it involves the simultaneous purchase and sale of either call options or put options with different strike prices but with the same underlying asset and expiration date. Whether a put or a call, the option with the lower strike price is bought and the one with the higher strike price is sold.

A bull call spread is also called a debit call spread because the trade generates a net debt to the account when it is opened. The option purchased costs more than the option sold.

The Basics of a Bull Spread

If the strategy uses call options, it is called a bull call spread. If it uses put options, it is called a bull put spread. The practical difference between the two lies in the timing of the cash flows. For the bull call spread, you pay upfront and seek profit later when it expires. For the bull put spread, you collect money up front and seek to hold on to as much of it as possible when it expires.

Both strategies involve collecting a premium on the sale of the options, so the initial cash investment is less than it would be by purchasing options alone.

How the Bull Call Spread Works

Since a bull call spread involves writing a call option for a higher strike price than that of the current market in long calls, the trade typically requires an initial cash outlay. The investor simultaneously sells a call option, aka a short call, with the same expiration date; in so doing, he gets a premium, which offsets the cost of the first, long call he wrote to some extent.

The maximum profit in this strategy is the difference between the strike prices of the long and short options less the net cost of the options — in other words, the debt. The maximum loss is only limited to the net premium (debit) paid for the options.

A bull call spread's profit increases as the underlying security's price increases up to the strike price of the short call option. Thereafter, the profit remains stagnant if the underlying security's price increases beyond the short call's strike price. Conversely, the position would have losses as the underlying security's price falls, but the losses remain stagnant if the underlying security's price falls below the long call option's strike price.

How the Bull Put Spread Works

A bull put spread is also called a credit put spread because the trade generates a net credit to the account when it is opened. The option purchased costs less than the option sold.

Since a bull put spread involves writing a put option that has a higher strike price than that of the long call options, the trade typically generates a credit at the start. The investor pays a premium for buying the put option but also gets paid a premium for selling a put option at a higher strike price than that of the one he purchased.

The maximum profit using this strategy is equal to the difference between the amount received from the sold put and the amount paid for the purchased put – the credit between the two, in effect. The maximum loss a trader can incur when using this strategy is equal to the difference between the strike prices minus the net credit received.

Benefits and Disadvantages of Bull Spreads

Bull spreads are not suited for every market condition. They work best in markets where the underlying asset is rising moderately and not making large price jumps. 

As mentioned above, the bull call limits its maximum loss to the net premium (debit) paid for the options. The bull call also caps profits up to the strike price of the option.

The bull put, on the other hand, limits profits to the difference between what the trader paid for the two puts — one sold and one bought. Losses are capped at the difference between strike prices less the total credit received at the creation of the put spread.

By simultaneously selling and buying options of the same asset and expiration but with different strike prices the trader can reduce the cost of writing the option. 

Calculating Bull Spread Profits and Losses

Both strategies achieve maximum profit if the underlying asset closes at or above the higher strike price. Both strategies result in a maximum loss if the underlying asset closes at or below the lower strike price.

Breakeven, before commissions, in a bull call spread occurs at (lower strike price + net premium paid).

Breakeven, before commissions, in a bull put spread occurs at (upper strike price - net premium received).

Real World Example of a Bull Spread

Let's say a moderately optimistic trader wants to try doing a bull call spread on the Standard & Poor's 500 Index (SPX). The Chicago Board Options Exchange (CBOE) offers options on the index.

Assume the S&P 500 is at 1402. The trader purchases one two-month SPX 1400 call for a price of $33.50, and at the same time sells one two-month SPX 1405 call and receives $30.75. The total net debt for the spread is $33.50 – $30.75 = $2.75 x $100 contract multiplier = $275.00.

By purchasing the bull call spread the investor is saying that by the expiration he anticipates the SPX index to have risen moderately to a level above the break-even point: $1,400 strike price + $2.75 (the net debit paid), or an SPX level of 1402.75. The investor’s maximum profit potential is limited: 1405 (higher strike) – 1400 (lower strike) = $5.00 – $2.75 (net debit paid) = $2.25 x $100 multiplier = $225 total.

This profit would be seen no matter how high the SPX index has risen by expiration. The downside risk for the bull call spread purchase is limited entirely to the total $275 premium paid for the spread no matter how low the SPX index declines.

Before expiration, if the call spread purchase becomes profitable the investor is free to sell the spread in the marketplace to realize this gain. On the other hand, if the investor’s moderately bullish outlook proves incorrect and the SPX index declines in price, the call spread might be sold to realize a loss less than the maximum.