Bull Spread

A bull spread is an options trading strategy used by the traders who want to seek profits when the price of the underlying security rises while limiting the losses.

There are two types of Bull Spreads -  

 

i) Bull Call Spread

A bull call spread can be constructed by buying a call option with a lower strike price while simultaneously selling a call option with a higher strike price,  on the same underlying security, expiring on the same date.

 

Example

Suppose the XYZ stock is trading at $32 and the option contract lot size is 100. A trader enters a bull call spread by buying ITM call at $30 for $300 and writing an OTM call at $35 for $100. The net investment required for the spread is $200.

Suppose the stock price of XYZ begins to rise and closes at $36 on the expiration date. Both options expire in-the-money, with the $30 long call having an intrinsic value of $600 and the $35 short call having an intrinsic value of $100. This means that the spread is now worth $500 at expiration and the net profit is $300.  

If the price of XYZ had declined to $29, both options expire worthless. The trader will lose his entire investment of $200 which is also his maximum possible loss.

 

ii) Bull Put Spread

Bull put spread can be constructed by buying a put option with lower strike price and simultaneously selling higher strike put option on the same underlying stock, expiring on the same date.

 

 

 

Example

Suppose the XYZ stock trading at $33. A trader enters a bull put spread by buying  OTM put at $30 for $100 and writing ITM put at $35 for $300. The trader receives a net credit of $200 while entering the spread position.

 

Suppose the stock price of XYZ begins to rise and closes at $36 on the expiration date. Both options expire worthless and the option trader keeps the entire credit of $200 as profit, which is also the maximum profit possible.

 

If the price of XYZ is declined to $29, both options expire in-the-money with the long call having an intrinsic value of $100 and the short call having an intrinsic value of $600. This means that the spread is now worth a negative $500 at expiration. Since the trader had received a credit of $200 when he entered the spread, his net loss comes to $300. This is also his maximum possible loss.