• HDFC securities
• 20 Feb 2023
• Knowledge Centre

 

Trading options can be a lucrative way to generate some extra income. One of the major benefits of trading options is that a trader has multiple strategies at their disposal. In this article, we will take a look at one such strategy known as the bull call spread which can help traders when they have a bullish outlook.

Before we take a look at the strategy, it is important to know what the options are. Options are derivative contracts. These contracts have no value of their own but derive their value from an underlying asset like stocks, indices, commodities or currencies.

There are primarily two option contracts that are traded - Call options and Put options. The value or price of an option contract is known as the premium.

Bull call spread strategy

 

The bull call spread strategy is an options strategy that can be deployed when a trader has a moderately bullish outlook on a security and expects the value of the asset to increase. A bull call spread is a two-leg strategy which means it includes two different options.

This strategy involves buying one at-the-money (ATM) call option and selling one out-the-money (OTM) call option of the same underlying and same expiration date. 

In the case of call options, if the strike price is equal to the spot price, it is known as at-the-money and if the strike price is higher than the spot price, it is known as out-the-money.

The bull call option strategy is a strategy in which the potential profit is known and the downside is limited which helps in reducing the risk.

How to execute the strategy?

 

In order to execute the strategy, you need to buy an ATM call option and sell an OTM call option. You need to ensure that the underlying and expiry for both options are the same.

When the price of the underlying increases, the value of the ATM option will give a profit while the sold OTM option will give a small loss. The total profit will be the difference between the two strike prices less the net premium paid.

The sold OTM option acts as a hedge against any downside move. If the price of the underlying falls at expiration, the trader can collect the premium received from the sold option and the maximum loss will be limited to the net premium paid.

Bull call spread is a limited reward, limited risk strategy. It is a ‘net debit’ strategy as you’re paying the premium towards the call option. Since the market can move in different directions after deploying the strategy, a trader can use a bull call spread calculator to ascertain the different payoffs in different scenarios.

It is important for a trader to be aware of the multiple risks associated with options trading. It is also critical to understand your own risk profile before entering into a trade. Doing your own research and understanding the different strategies available can help to minimize the risks and maximize the potential returns.