Bull Call Spreads
The Bull Call Spread (BCS) is an excellent strategy for a moderately bullish investor. This strategy allows for limited risk and attractive upside potential. The Bull Call Spread involves the combination of two legs (sides), both buying a lower strike call option and selling a higher strike call option on the same underlying at or before the lower strike expiration. This trade is a debit spread, meaning it will cost you money to enter this trade. The debit, or net premium paid, is all that you risk in this strategy.
Some of the attractive features of this trade are the fact that there is limited downside. There is also less risk in the BCS versus a long call option purchase. Let's examine why this is the case.
Investor A is Bullish on BVF(trading at $20.00) and decides to buy 10 Oct $20 BVF Calls @ 1.25, for a total investment of $1,250.00
Investor B is also Bullish on BVF, but decides to use a BCS to lower his risk. Investor B's trade looks like this....
Buy 10 Oct $20 BVF Calls (@1.25)
Sell 10 Oct $25 BVF Calls (@ 0.50) for a net debit of $0.75, or in this case $750.00.
Investor A has a total risk of $1,250.00 and unlimited upside potential. Theoretical breakeven is $21.25 (strike price plus premium paid) at expiration.
Investor B has a total risk of $750. The maximum reward investor B has is $4,250.00 ($5 per spread minus $0.75 cost x 10 x 100). Investor B paid $1,250.00 for the $20 Calls and received $500 for the $25 Calls he sold, so his net cost on the trade is $750. The drawback with the BCS, is that some upside is foregone, in this case, the investor no longer gets any upside past $25 should BVF continue higher. This is because for every dollar gained on the $20 Calls above $25.00, the $25 Call that was sold will be losing dollar for dollar. Investor B's breakeven at expiration is $20.75.
An attractive feature of the BCS is that the investor can choose to be bullish, but with less investment dollars at risk. Or, the investor can nearly double the amount of contracts controlled for roughly the same initial investment as investor A. An investor that utilizes Bull Call Spreads, is spreading their risk by selling the higher strike call to receive premium.
