The bull call spread and the bull put spread are option strategies used when an investor expects the price of the underlying security to increase.
These strategies can be helpful and profitable when used correctly. This article will explain everything there is to know about the bull call spread and bull put spread strategies.
If investors need a reminder of what call and put options are, then click on this article.
A bull call spread is when an investor purchases a call option at a certain strike price while simultaneously selling a call option with the same expiration date, but at a higher strike price. The potential profit from this strategy comes from owning the call option. Selling the other option reduces the cost for the option that is bought.
The maximum profit is the difference in the strike prices between the option bought and the option sold, minus the total cost of both options. As the underlying security’s price increases up to the strike price of the sold option, the profit increases. However, this strategy will not profit further beyond the sold option’s strike price.
Let’s look an example.
Assume a stock is trading at $15. An investor buys one call option with a strike price of $20 for a premium of $1 per share. Simultaneously, he sells one call option with a strike price of $22 for a premium of $0.50 per share. The total cost of the trade is $0.50 (1 – .50 = .50). Assume the underlying stock moves to $24. Any movement above $22 is forfeited. Therefore, the total profit of this trade is $1.50 per share ((22 – 20) – .50 = 1.50).
Now let’s look at a bull put spread.
A bull put spread is when an investor purchases a put option at a certain strike price while selling a put option with the same expiration date, but at a higher strike price. In this strategy, the investor hopes that the price of the underlying will be above the higher strike price at expiration.
The put option with the higher strike price is more expensive than the put option with the lower strike price. Essentially, the trader sells the more expensive put option to pay for the less expensive put option. He hopes that both options expire worthless with the rise in the underlying security’s price. If this happens, his total profit is the premium paid to him for selling the put option minus the cost of buying the other put option.
Let’s look at an example of this.
Assume a stock is trading at $80. An investor buys one put option contract with a strike price of $75 for a premium of $3 per share. At the same time, he sells one put option with a strike price of $85 for a premium of $8. Assume the stock price expires at $81. In this case, both options expire worthless. The investor’s total profit would be $5 per share (8 – 3 = 5).
Both of these strategies offer the opportunity to profit when an investor expects the price of the underlying security to increase. These are good strategies to keep in mind when trading options.