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Pros And Cons Of Bull Call Spread Option Trading

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Pros And Cons Of Bull Call Spread Option Trading

Let us briefly look at the positive and negative aspects of a trading strategy called Bull Share trading. 

In a beginner’s guide method of learning, the terminology and practice will be broken down to a very basic level of understanding.

The strategy in trading that is called the bull call spread option is used when the options trader believes an underlying security or asset price will elevate in a positive fashion. 

This is always set within a predicted time frame of happening within the near future. 

The initial investment and financial outlay for this will be entered as a debit.

So the strike price of the option is different from the current trading price of the underlying asset.

The way in which this is done is when the options trader buys ATM or at-the-money call option and at the same time an elevated OTM, or out-of-the-money call option is entered on the same underlying security and in the same month of trading.

To look at the graph below in their Bull Call Strategies: SPX Bull Call Spreads section, it is plain to see when the call option is made at a lower level and when the predicted elevation and profitability will occur.


The graph below clearly shows the positive outcome of the bull call spread strategy:

bull-can-spread-1,jpeg

By entering a short-term out-of-the-money call, an options trader will lessen the financial outlay to give the bullish position a foundation. 

The negative point is that if the underlying security experiences a sharp rise in price that establishes itself in the longer term, that cost escalation is not accessible.

As the options trader takes on a debit to enter trading, this method of trading is also known as a bull call debit spread.

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The Positive Aspect of Bull Call Spread Option Trading

To further understand the reasons why this approach of options trading is implemented it is necessary to view a graph of what happens when the stock price of the underlying security elevates beyond the estimated strike price and within the stipulated time frame. 

This will show when the strategy pays off.

This graph displays their graph of the bull share spread payoff function and example:

p2.2

As long term options are viewed as a more stable portfolio option, this method is used to create some upside potential which leads to a cheaper option strategy overall.

The biggest potential for this approach is hit when the underlying security price rises higher than the strike price that was entered. 

The difference between the two call options is offset against the amount that was initially the debit for the bull call spread option.

  • This is explained in a straightforward formula that is used to calculate the profitability of the strategy. This formula is basically:
  • The Strike Price of the Short Call
  • the Strike Price of the Long Call
  • the Net Premium Paid
  • Commissions Paid
  • Equals the Maximum profit and gain.

The Negative Aspect of Bull Call Spread Option Trading

As can be very clearly seen in the graph below, it is critical to choose to practice the bull call spread option with underlying securities that elevate in price. 

This chart is a diagram of a bull call debit spread and a bull put credit spread. 

The options trader starts the process with a debit buy call and within the time frame of the month two things hopefully happen.

Firstly, it is essential for profit that the underlying security goes up in price.

Secondly, that the price manages to elevate enough to show a maximum profit in that time frame for the options trader to satisfy the creditors mentioned in the formula above.

p2.3

If this does not happen, the bull call spread strategy will incur financial losses for the options trader. 

So if the underlying asset prices dip below the predicted elevation and time on the range, it is essential that it does not decline below the debit amount that was undertaken to enter the spread in the beginning.

A simple formula makes it a bit clearer, to estimate this negative aspect of the options:

  • The Net Premium Paid
  • Plus the Commissions Paid
  • Will equal the maximum loss incurred. The loss will occur when the price of the underlying security is bigger than the final strike price of the option called.

The Third Possibility- Breaking Even

There is the possibility that the options trader could break even after participating in a bull call spread. 

This happens when the final long call strike price added to the net premiums paid out leads to neither profit or loss.

Although the examples given here are related to stock options, the practice of the bull call spread option trading can be applied to options on the futures market, ETF options and index options too.

When using this trading, it is important to take into consideration that commission charges are added to every trade. 

This comes into effect whether the outcome of the options trade has been positive, negative or a break even. 

This is a relatively small amount and can be around the $10 to $20 mark. 

Option brokerages differ across the board.

If an option trader is particularly active, this can end up consuming a considerable amount of the profitability of effort expended and financial outlay. 

In this instance for a dealer who is busy with big numbers of contracts, it would be necessary to search for a commission broker with the lowest fee per contract.

There are potentially less risky strategies when practicing bull call spread options. 

Variously some options are:

  • The Collar Strategy
  • The Bull Put, Spread
  • The Zero Cost or Costless Collar Strategy.

They are, as the name suggests, low risk and with low profitability. 

But are excellent ways to dip into the markets as a beginner.

For the more seasoned veteran, one could widen the margin of difference in the call options of the strike price. 

This will call for a more precipitous rise in the price and is more aggressive.

Trading options are an exciting experience when using the strategy of bull call spreads.

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