Bull Call Debit Spread

Bull call spreads are debit spreads that consist of buying a call option and selling a call option at a higher price. The strategy looks to take advantage of an increase in price from the underlying asset before expiration. Increased implied volatility will also benefit the bull call debit spread.

A bull call debit spread is entered when the buyer believes the underlying asset price will rise before the expiration date. Bull call spreads are also known as call debit spreads because they require paying a debit when the trade is entered. The risk is limited to the debit paid at entry. The maximum profit potential is the width of the spread minus the debit paid. To break even on the position, the stock price must be above the long call option by at least the cost to enter the position. The further out-of-the-money the bull call debit spread is initiated, the more aggressive the outlook.

A bull call debit spread is made up of a long call option with a short call option sold at a higher strike price. The debit paid is the maximum risk for the trade. The maximum potential profit is the width of the spread minus the premium paid. The closer the strike prices are to the underlying’s price, the more debit will be paid, but the higher the probability the option will finish in-the-money. The larger the width of the spread is between the long option and the short option, the more premium will be paid, but the maximum potential profit will be higher.

The bull call spread payoff diagram clearly outlines the defined risk and reward of debit spreads. Bull call spreads require a debit when entered. The debit paid is the maximum potential loss for the trade. Because a short option is sold to reduce the trade's cost basis, the maximum profit potential is limited to the width of the spread minus the debit paid.

For example, if a $5 wide bull call debit spread costs $2.00, the maximum gain is $300 if the stock price is above the short call at expiration, and the maximum loss is $200 if the stock price is below the long call at expiration. The break-even point would be the long call strike plus the premium paid.

‍

A bull call spread consists of buying-to-open (BTO) a call option and selling-to-open (STO) a call option at a higher strike price, with the same expiration date. This will result in paying a debit. Selling the higher call option will help reduce the overall cost to enter the trade and define the risk, but will also limit the profit potential.

For example, if an investor believes a stock will be above $50 at expiration, they could buy a $50 call option and sell a $55 call option. If this costs $2.00, the maximum loss possible is $200 if the stock closes below $50 at expiration, and the maximum profit potential is $300 if the stock closes above $55 at expiration. The break-even point would be $52.

Bull call debit spreads can be entered at any strike price relative to the underlying asset. In-the-money options will be more expensive than out-of-the-money options. The further out-of-the-money the spread is purchased, the more bullish the bias.

A bull call debit spread is exited by selling-to-close (STC) the long call option and buying-to-close (BTC) the short call option. If the spread is sold for more than it was purchased, a profit will be realized. If the stock price is above the short call option at expiration, the two contracts will offset, and the position will be closed for a full profit.

For example, if a bull call debit spread is opened with a $50 long call and a $55 short call, and the underlying stock price is above $55 at expiration, the broker will automatically buy shares at $50 and sell shares at $55. If the stock price is below the long call option at expiration, both options will expire worthless, and the full loss of the original debit paid will be realized.

Time decay, or theta, works against the bull call debit spread. Every day the time value of the long options contract decreases. Ideally, a large move up in the underlying stock price occurs quickly, and an investor can capitalize on all the remaining extrinsic time value by exiting the position.

Bull call debit spreads benefit from an increase in the value of implied volatility. Higher implied volatility results in higher options premium prices. Ideally, when a bull call debit spread is initiated, implied volatility is lower than it is at exit or expiration. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Bull call debit spreads have a finite amount of time to be profitable and have multiple factors working against their success. If the underlying stock does not move far enough, fast enough, and/or volatility decreases, the bull call debit spread will lose value rapidly and result in a loss. Bull call spreads can be adjusted like most options strategies but will almost always come at more cost and, therefore, add a debit to the trade and extend the break-even points.

If time is running out before expiration, the entire spread can be rolled out to a later expiration date. If the stock price moves down and away from the bull call spread, a bear put debit spread could be added at the same strike price and expiration as the bull call debit spread. This would create a long butterfly and allow the position to profit if the underlying price continues to decrease. The additional debit spread will cost money and extend the break-even points.

Bull call debit spreads can be rolled out to a later expiration date if the underlying stock price has not moved enough. This is accomplished by selling the existing bull call spread and re-purchasing a new spread for a debit with the same or different strike prices at a later expiration date. This will cost money but will extend the duration of the trade.

Bull call debit spreads can be hedged if the underlying stock has moved down in price. To hedge the bull call spread, purchase a bear put debit spread at the same strike price and expiration as the bull call spread. This would create a long butterfly and allow the position to profit if the underlying price continues to decline. The additional debit spread will cost money and extend the break-even points.