A bull call spread is an options trading strategy to profit from an increasing share price. The advantage of using an options combination is the much lower cost to set up a trade compared to buying the shares of stock. The underlying shares of stock for a bull call spread rarely are a factor in the trade.
Options contracts give traders the right to buy or sell an underlying stock at a set price for a specific period of time. Options trade on a separate exchange, with option values based on the changes in the underlying stock. Call options -- used in a bull call spread -- give the option buyer the right to buy the underlying stock at a specific price. The option seller receives the premium for the call options and must deliver the shares if the buyer exercises the contract. The strike price is the stock share price at which a call option will be exercised and each stock option contract covers 100 shares of the underlying stock.
Bull Call Spread
A bull call spread is established by buying call options with a strike price near or just above the current stock price and selling an equal number of call options at a higher strike price. The bought calls will increase in value as the stock rises and the sold calls reduce the cost to set up the trade. The maximum profit is the difference between the strike prices minus the cost of the spread. The maximum profit potential is reached if the stock price moves up to strike price of the sold calls or higher.
Effects on Shares
The purchased call options give the trader the right to exercise the options and buy the underlying shares. The sold call options commit the trader to buying shares if the option buyer elects to exercise. The sold options would only be exercised if the stock rose above the higher strike price. If the options were exercised, the trader must deliver the shares. However, the trader could exercise the purchased call options to acquire the necessary stock shares. The whole operation would be handled by the trader's options broker, completing the exercise of the both ends of the options spread and delivering the shares to the buyers of the sold call options. The options trader would collect the difference between the two strike prices.
Closing Out a Spread
In most cases, the options used to establish the bull call spread will not be exercised by or to the trader. The spread will have a specific expiration date and if the trade is profitable, the trader will close out the trade before expiration is reached by reversing the opening trade -- buying the sold options and selling the purchased options. The values of the options contracts will reflect the changes in the underlying stock value, eliminating the need to take possession of the shares. If the stock moved in the predicted direction -- up for a bull call spread -- the profit from the trade is realized without ever buying or selling any stock shares.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.