Trading Strategy: The Bull Spread
Option Trading Bull Spread Strategy
A Bull Spread, is as the name implies, a spread position in which the investor takes a bullish position. That is, the investor makes the trade on the belief that the share price of the underlying stock will rise prior to expiration. Like most spreads, the bulls spread limits both the overall possible profitability of the trade as well as the possible maximum losses of the trade.
A bull spread is a vertical spread. It is created by buying calls at one strike price and selling a matching number of calls at a higher strike price. This is typically done with both sets of calls having the same expiration date.
To establish a bull spread, an investor purchases a call at the lower strike price. The debit for this trade, plus commissions, represents the maximum potential loss for this options strategy. The investor then sells a call at a higher strike price and collects the premium for this call. The higher priced call is always further out of the money (or less in the money) than the lower priced call. As a result, bull spreads always result in a net debit to the options trader. The amount of the debit is equal to the difference between the price paid for the call minus the (lesser) amount received for selling the higher priced call.
The bull spread strategy achieves its maximum profitability if the stock price is anywhere above the higher strike price at expiration. The trade can be closed prior to expiration, however, this results in incurring additional trading commission expenses, so the best-case scenario is for the spread to expire, rather than be closed out. Obviously, if the investor feels there is a strong likelihood of the stock price reversing, than closing the spread is preferable to allowing the trade to become a losing one.
The maximum loss for this strategy occurs if the stock price at expiration closes anywhere below the lower call’s strike price. This amount is limited to the initial debit incurred for putting the trade on.
Although bull spread’s provide limited profitability, the amount of profit can actually be very large on a percentage basis. Considering the overall spread costs less than buying the calls outright, this limitation is one many investors are willing to take.
