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In options trading, bull spreads are option strategies to capitalise on their bullish outlook for a particular asset. These strategies offer traders the potential to profit from price increases while minimising risk.
This article explains bull spreads, for both call and put variations, while exploring their mechanics, market conditions ideal for their application, and essential tips for successful implementation.
Meaning of bull spread
The bull spread is an options strategy employed by traders anticipating a modest or moderate increase in the underlying asset’s price. It involves the simultaneous purchase and sale of securities or assets with the same expiry duration but different strike prices.
There are two types of bull spread strategies:
The Bull Call and the Bull Put.
In a bull call spread, the trader pays the premium upfront and can earn profits at expiration. In a bull put spread, the trader receives the premium upfront and aims to retain as much of it as possible until expiry.
Both strategies allow traders to earn premiums from selling their options, requiring a lower initial investment than simply buying the options. Traders realise maximum profits when the underlying asset closes at or above the higher strike price they set.
What is bull call spread?
A bull call spread strategy involves using call options to benefit from an anticipated price increase in the underlying asset.
The primary goal of a bull call spread is to limit potential losses and decrease the cost of the trade, allowing the investor to enjoy gains if the asset’s price rises but caps the maximum profit, as the short call offsets some of the profit potential.
What is bull put spread?
A bull put spread is a strategy used by those who expect a moderate increase in the underlier’s price.
It involves two put options where the investor buys one at a lower strike price and sells another put option at a higher strike price.
Bull spread option strategy
The bull spread is an options trading strategy designed to profit from a moderately bullish market outlook while minimising risk. It involves using two call options on the same asset and the same expiry date.
In a bull call spread, an investor engages in a dual call option transaction. They purchase a call option with a lower strike price (known as the long call) and also sell a call option that has a higher strike price (known as the short call). This approach capitalises on an expected asset price rise.
With the long call, the investor secures the right to buy the underlying asset at the lower strike price, while the short call commits them to sell the asset at the higher strike price. Selling the short call serves to lower the overall trade expenses.
Bull call spread example
Bull call spread = Long call (purchase a call option at a lower strike price) + Short call (sell a call option at a higher strike price)
Typically, a bullish call spread involves using in-the-money long calls and out-of-the-money short calls. Here, in-the-money is an option having intrinsic value and can lead to a profit if exercised, whereas out-of-the-money does not have intrinsic value and cannot generate profit if exercised.
However, adjustments can be made based on the trading spread and time until expiration to optimise gains and limit potential losses.
Take a hypothetical example where the trader is Aman-
Aman is confident that the stock of Company X, currently trading at ₹ 100 per share, will increase in value. He initiates a bull call spread strategy.
- He buys a call option with a strike price of ₹ 100 and a premium of ₹ 5.
- He sells another call option with a higher strike price at ₹ 110 and receives a premium of ₹ 3.
- Aman’s total net premium outlay is ₹ 2 (₹ 5 – ₹ 3).
Benefits of Aman trading through this strategy:
- By combining buying and selling call options, he limited potential losses.
- The net premium outlay was only ₹2, reducing upfront investment.
- Aman can profit if the stock surpasses ₹110, thanks to the lower strike call option’s gains exceeding the premium paid. This strategy allows profit with risk management and cost control.
In summary, bull spreads offer strategic options for capitalising on bullish market trends. These strategies provide structured approaches that help by studying the price movements from the uptrend and reducing losses.
It is for conducting research and considering the market environment before applying bull spreads effectively.
While both strategies are aimed at having a balanced profit and less risk, the two focus on two different options – call and put.
– A bull call spread is suitable when the price is expected to move upward. Bull put spread is suitable when a mild upward is expected.
– Bull call buys a call and sells another call at a higher strike price. Bull put buys a put and sells another put at a higher strike price.
Bullish and bearish are two different outlooks towards the market. A bull put spread involves buying a put option and selling another put option at a higher price. A bear put spread option involves buying a put option at a higher price and selling a put option at a lower strike price.
Both bull spreads are limited profit strategies. The bull put spread earns the maximum profit when the asset’s market price goes above the short put (the put option contract that is sold) option’s strike price, on the expiration date.
Using the bull spread strategy while trading in currency is called the bull currency spread. It involves buying and selling a call option or buying and selling a put option on the same currency, at different strike prices.
An option spread works by using a spread of options. Traders using these strategies enter into different calls and put options on the same asset, expiring on the same day, at different strike prices. Traders try to profit from the difference between the premium received and the premium paid.