A call option is a derivative product that gives the buyer an option, but not the obligation, to buy a security from a seller at a predetermined price before the expiration of the contract. To maximize profits, some traders buy these call options in strategic proportions under a well-managed plan called an options trading strategy.
A ‘bull call spread’ is also an options trading strategy that helps a trader to profit from a slight increase in the price of a stock. The strategy uses two call options to create a range with a lower strike price and an upper strike price. This helps in deducting the cost incurred on account of the stock.
Essentially, the bull call spread consists of three phases:
a, A trader first looks at a security that may see a slight increase in price over time.
b, The trader would then buy a call option with a strike price higher than the market price. Here the merchant will pay the premium
C, Also, the trader will sell a call option at a premium with an even higher strike price and the same expiration date as the first call purchased. In this case, the trader will collect the premium.
The premium received by selling the call will partially take care of the premium paid for buying the call. So, the difference between the two call options is the cost incurred in the option strategy.
Essentially, traders use bull call spreads when they expect a security’s prices to rise marginally and not substantially, and when stock prices experience volatility.
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At the time of option expiration, if the market price of the security drops below the lower strike price, the trader will not exercise the option. As a result, the trader will incur a loss to the extent of the net premium paid for availing the options. At the same time, if the stock price rises above the upper strike price, the trader will exercise a buy call, allowing them to buy the stock at a price below the market price.
The profit earned will be the difference between the lower strike price and the higher strike price which is the net premium paid.
Therefore, the bull call spread is a good options strategy that limits the risk involved in buying call options. Also, the strategy has the disadvantage that the profit is also limited to the difference between the two strike prices.
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