Bull Call Spread Strategy

In the previous blog, we discussed the Long Strangle Strategy, a popular approach to get benefits from a stock's price in case of a big move either way. The strategy benefits from the market volatility and is perfect when one is not sure about the movement direction of a stock. Let's discuss another strategy: Bull Call Spread, a rather conservative approach to capitalizing on moderate bullish market conditions.

The Bull Call Spread is an extremely popular option strategy for those moderately bullish. It lets the traders take advantage of the upside in the stock price while at the same time putting a cap on the potential losses that may arise from this.

What is a Bull Call Spread?

A Bull Call Spread is executed by buying one lower striking call option and selling one higher striking call option, but they must have the same date of expiration. This strategy will profit with a moderate rise in the price of the underlying stock at reduced cost compared to buying one call option.

Let's say, for instance, Reliance Industries is trading at ₹2,000. You expect its price to increase, but you are not really expecting a big jump. Instead of buying one call option, you will implement a Bull Call Spread to limit your risk.

How is it done in a Bull Call spread?

Here is an example of how you would execute a Bull Call Spread in steps:

1. Buy the call option with a strike price of ₹2,000, expiring in one month. We will assume that a premium for such an option will be ₹ 100 per share.
   
2. Sell a call option with strike price of ₹2,100 and the same expiry. The premium one is receiving for the option is ₹50/- per share.
   

The net cost of the strategy is the premium paid for buying the call option minus the premium received for selling the call option:

• Premium Paid for the call option: ₹ 100
  
• Premium received for call option: ₹50
  
• Net Premium Paid: ₹100 - ₹50 = ₹50 per share
  

Therefore, risk a maximum of ₹50 per share.

Profit Potential

Maximum profit limited, but still providing decent return:

• Both the call options will be exercised if at expiration, Reliance goes up to ₹ 2,100 or higher. You can purchase the stock with the long call at ₹ 2,000 and sell it with the short call at ₹ 2,100, hence earning ₹ 100 per share.
  
• Net Profit: ₹ 100 differences in strike prices - ₹ 50 paid premium = ₹ 50 per share.
  

So, your profit would be maximum 50 ₹/share by the difference of strike prices minus premium.

When to use a bull call spread?

The Bull Call Spread is perfect when you anticipate a stock's price to rise moderately. You might use it in the following scenario:

1. Moderately Bullish Market: You think that the price will increase but it will not fluctuate wildly.
   

2. Stable Stocks: Large Cap stocks like TCS, Infosys, or HDFC, those that move accordingly, slowly and steadily, are the best fit for this strategy.
   

3. Cost Efficiency: This strategy is appropriate for those who want to reduce the upfront cost of buying a call option.
   

Risks of the Bull Call Spread

Although the Bull Call Spread is safer than outright buying one call option, some risks are associated with it:

Limited Profit: The very maximum profit is limited to the difference between the strike prices, so your gain is capped.

Expiration Risk: You could lose that premium you paid if the stock does not move above the strike price of the sold call at expiration.

Conclusion

As we discussed the Bull Call Spread Strategy, which works as an efficient way to capitalize on the moderate 'bullish' moves with limited risks. While the Bull Call Spread is considered ideal for rising markets, its cousin Bear Put Spread will come into play for those traders who expect a stock's price to decline. Let's look at how a Bear Put Spread works and how it helps you make gains from a bearish outlook.