This page explains bull call spread profit and loss at expiration and the calculation of its maximum gain, maximum loss, break-even point and risk-reward ratio. Bull call spread, also known as long call spread, is a bullish option strategy, typically done when a trader expects the underlying security to increase in price, but not too much.
It has limited risk and limited upside potential. A bull call spread position consists of two call options — buying a lower strike call and selling a higher strike call.
It is a debit spread negative cash flow when entering the position , because the price you pay for the lower strike call is typically higher than the price you get for selling the higher strike call. We will explain the profit and loss profile and the calculation of maximum gain, risk and break-even point on an example. The objective of a bull call spread trade is for the underlying price to increase before the options expire, so that our long call option ends up in the money by such amount that will offset the initial cost and make a profit.
Assuming we hold the position until expiration, there are three possible scenarios. Both options expire worthless and there is zero cash flow at expiration.
Maximum possible loss , or risk of a bull call spread trade is equal to initial cost and applies when underlying price ends up below or exactly at the lower strike.
The ideal scenario is that the underlying price goes up and ends up at or above the higher strike at expiration. When this happens, both our call options are in the money. Maximum possible profit from a bull call spread equals the difference between strikes times number of shares minus initial cost. It applies when the underlying ends up above or exactly at the higher strike. So we know what happens when the underlying ends up below the lower strike maximum loss and above the higher strike maximum profit.
What if it ends up between the two strikes? Below the higher strike the short call is out of the money. The outcome at expiration therefore depends entirely on the long lower strike call. The higher the underlying price gets above the lower strike, the greater the gain at expiration. Near the lower strike it approaches maximum loss; near the higher strike it approaches maximum profit.
In the graph below you can see how the profit or loss behaves under the different scenarios and how the two options are driving it.
The short call option is still out of the money. Besides the two strikes, the most important point in the chart is the moment when total payoff crosses zero and the trade starts being profitable — the break-even point. It is the underlying price at which the lower strike call option value is exactly equal to the initial cost of the entire position. Knowing the maximum loss scenario 1 and maximum profit scenario 2 we can also calculate the risk-reward ratio. Risk-reward ratio is therefore 1: Bull call spread profit and loss profile is very similar to bull put spread.
The difference is obviously that the latter uses puts rather than calls and it is a credit spread the position is entered with net positive initial cash flow. Another strategy with similar, bullish payoff is collar.
It is best used when you are already long the underlying stock and want to create an exposure similar to bull call spread limited risk and limited upside. Bull call spread and bull put spread payoff profiles are inverse to bear put spread and bear call spread , which as their names suggest are bearish strategies profit when underlying price goes down. The latter is actually the exact other side of bull call spread you sell the lower strike call and buy the higher strike call.
Bull call spread is also closely related to plain and simple long call , as both are bullish and have limited risk. For these benefits you of course pay with limited upside.
Therefore, if you think the underlying price might jump substantially, a long call might be a more suitable trade; if you think a greater increase in price is unlikely, a bull call spread might offer lower cost and better odds.
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No financial, investment or trading advice is given at any time. Bull Call Spread Basic Characteristics Bull call spread, also known as long call spread, is a bullish option strategy, typically done when a trader expects the underlying security to increase in price, but not too much. Scenario 2 Maximum Profit The ideal scenario is that the underlying price goes up and ends up at or above the higher strike at expiration. Scenario 3 Between the Strikes So we know what happens when the underlying ends up below the lower strike maximum loss and above the higher strike maximum profit.
Bull Call Spread Payoff Diagram In the graph below you can see how the profit or loss behaves under the different scenarios and how the two options are driving it. Bull Call Spread Break-Even Point Besides the two strikes, the most important point in the chart is the moment when total payoff crosses zero and the trade starts being profitable — the break-even point. The general formula for bull call spread break-even point is: Below you can see the general formulas:More...