Bull Spread is one of the most popular options spread trading strategies. And as the name suggests, it is a bullish strategy with both minimal risk and potential for profit. This strategy works well in a rising market, also known as the bull market. Hence, it is referred to as a bull spread, and it works for both the types of options, calls, and puts. It entails buying and selling of the same type of options (either calls or puts) simultaneously, with the same expiration date and underlying asset but different strike prices. Irrespective of a call or a put, the one with the lower strike price is bought, and the one with the higher strike price is sold.
Two types of bull spreads
- Bull Call Spreads- this uses only call options
- Bull Put Spreads- this uses only put options
A Bull spread can be created in one of the two ways shown below-
- Long (Buy) a low strike call and Short (Sell) a high strike call
- Long (Buy) a low strike put and Short (Sell) a high strike put.
Bull Call Spread
This strategy is used when the outlook of the trader on the stock/index is ‘moderately bullish’ and not very ‘aggressive.’ As the name suggests, it uses call options. In this, a trader buys a call option at a lower strike price – at At The Money (ATM) and sells a call option with a higher strike price. The underlying asset and the expiry remain the same. If a trader believes the stock price will rise but not over the strike price of the call they are selling, they should use this approach.
Let’s take an example, a trader is optimistic on the market, so he buys a call option for the strike price of 10200 by paying a premium of 350, and he expects the market to not go above 10800, so he shorts a 10800 call option and receives a premium of 140.
Option | Call | Call |
Long/Short | Long | Short |
Strike | 10200 | 10800 |
Premium | (350) | 140 |
Net Cost= ((350) – 140) = (210)
Maximum Profit
Profit in this strategy is limited to the difference between the two strike prices minus the net cost, which is the difference between the premium paid and received. As per the above example, the difference between the strike price is 600 (10800-10200= 600), and the net cost (debit) of the two calls bought and sold is 210 (350-140). The maximum profit, therefore, is 390 (600-210= 390). Hence,
Maximum Profit = Difference between the two strike prices (High Strike price – Lower strike price) – net cost
Maximum Loss
The maximum loss is the cost of the spreads or the premiums paid for both calls. Only if the stock price falls below the lower strike price at expiry can this happen. In the example above, the maximum loss can be 210.
Breakeven
A breakeven happens when there is no profit or no loss for the trader. In this strategy, a trader will reach a breakeven point when the price of the underlying asset rises above the strike price of a long call option by an amount equal to the net cost. In this case, by 210.
Breakeven= Long Call strike price (Lower strike) + net cost
In this example: 10200 + 210= 10410
Bull Put Spread
As the name suggests, this strategy is also used when the outlook on the market is bullish, and it uses put options. In this, a trader shorts a put with a higher strike price and buys one put with At the Money (ATM) lower strike price. Here also, both the puts have the same underlying asset and same expiration date. This type of strategy typically generates credit at the start because he pays the premium when buying a put but also gets a premium while selling a put at a higher strike price than that of the one purchased.
Let’s look at an example where the trader sells a put option of strike price 10800 and receives a premium of 300 and simultaneously buys a put option of strike 10500 and pays a premium of 130-
Option | Put | Put |
Long/Short | Short | Long |
Strike | 10800 | 10500 |
Premium | 300 | (130) |
Net Credit= (300 – 130) = 170
Maximum Profit
The maximum profit, in this case, will be the net premium received by buying and selling of puts. When the price of the underlying asset is equal to or greater than the strike price of the put sold (higher strike) at expiry, and both puts expire worthlessly, then the profit is realized. In this case, the maximum profit will be 170.
Maximum Loss
The difference between the strike prices minus the net premium received, which we calculated above, is the maximum loss. In this case, the difference between the strike prices is 300 (10800-10500= 300), and the net credit is 170 (300- 130= 170). Hence, the maximum loss is 130 (300 – 170= 130).
Maximum Loss= High Strike price – Low strike price – Net credit
Breakeven
Breakeven here occurs when at the expiration date, the price of the underlying asset falls below the strike price of the short put option by an amount equal to the net premium received. In this case, by 170.
Breakeven= Strike price of short put (Higher strike) – net premium received
In this example: 10800 – 170 = 10630
Final Words
This strategy is not suited for all market conditions. These work well in markets where the trader expects the price of the underlying asset to rise moderately. However, if a trader anticipates a substantial increase in the price of the underlying asset, this strategy will not be suitable.
The losses and profits are limited in both types of bull spreads (Bull Call Spread and Bull Put Spread). Loss is limited to the net cost of the spread, and profit is limited to the difference between the strike prices minus the net cost in the case of Bull Call spread. In the case of a Bull Put Spread, the loss is limited to the difference between the strike prices of the puts minus the net premium received, and profit is limited to the net premium received. Hence, this strategy is suitable for traders who are willing to accept a low return in exchange for a low risk.