.png)
Bull Cap Spread
This is a bullish options strategy that is utilized when an investor anticipates a fair increase in a stock price, It encompasses buying a call option at lower strike price and selling synchronously selling a call option at a higher strike price. The both options share the same expiration date. This strategy limits both the potential profits and the potential loss, making it a defined-risk, defined-reward trade.
Elements of a Bull Call Spread
1. Buy Call Option (Long Call): The investors purchases a call option with a lower strike price, expecting the stock will rise .
2. Sell Call Option (Short Call): The investor sells a call option with a higher strike price, which balances out part of the cost of the long call but limits the maximum profits.
​
Profit and Loss
-
Max Profit: This happens when the stock price takes a position above the higher strike price by the expiration.
-
Max Loss: The cost of entering the trade (the net premium paid), which occurs if the stock price stays below the lower strike price by expiration.
-
Breakeven Point: The stock price at which the strategy neither makes nor loses money, calculated by adding the net premium paid to the lower strike price.
An Illustration Using Apple Stock (AAPL)
Assuming Apple's stock is trading at $180, and the investor expects a moderate rise in its price. The investor decide to set up a Bull Call Spread:
-
Buy a 180 strike call ( lower strike): Costs the investor $8 per share which is a total of $800, as each option controls 100 shares.
-
Sell a 190 strike call (High Strike): The investor gets $3 per share which is a total of $300.​
Important Transactional Notes
-
Net Premium Paid = $800 (Long call) - $300 (Short Call) = $500.
-
Maximum Loss = $500, this is the amount the investor paid for the spread (net premium).
-
Maximum Profit = This is calculated by: Difference in strike Prices - Net Premium Paid = ($190 - $180) - $500 = $500.
Outcome Scenarios
1. Stock Price Rises Above $190:
This is the best possible outcome. The long call allows the investor to buy the stock at $180, while the short call obligates the investor to sell it at $190. This results in a maximum profit of $500 i.e. excluding transaction fees.
2. Stock Price is positioned between $180 and $190: The investors gains some profit, but less than the maximum. For instance, if Apple's stock ends at $185, the long call is worth $5 ($185-$180), and the short call expires worthless. The investor's profit would be $500 - $500 (premium paid), leaving the investor at a breakeven.
3. Stock Price remains Below $180: The long and short calls expire worthless, and the investor loses the $500 premium paid, which is his maximum loss.
Why Use a Bull Call Spread
Limited Risk: The investor's maximum loss is limited to the premium paid. This makes Bull Call Spread more conservative than buying a call option.
Cost Efficiency: The short call reduces the cost of buying the long call.
Limited Reward: While the investor's potential profit is capped, he profits from a fair rise in the stock price with lower upfront costs.
In Conclusion
A Bull Call Spread is a bullish strategy utilized when an investor expects a moderate rise in a stock's price. The investor can profit from the price increase while limiting risk by purchasing a lower strike call and selling a higher strike call. Just as in the case of the Apple stock, the strategy lets you participate in upward price maovement while keeping your potential loss limited to the net premium paid.