bull call strategy part 2

With this strategy, your potential loss is limited to the premium you paid for the calls less commissions and the premium you collected for the calls you sold. Unlike the outright purchase of a call option, your potential profits are limited to the difference between the strike prices multiplied by 100 times the point value of the contract, less the cost of establishing the position. An option calculator such as Option-Aid performs these calculations for you instantaneously.

When we initiate a Bull Call Spread, the call that we purchase is normally at-the-money. We try to allow enough time for the market to make the anticipated move. The call we sell has the same expiration date, with a higher strike price (at a price point that we feel the asset can easily move to within the time period until expiration, yet not too high because it lowers the premium we are collecting to lower our cost basis).

It is important to discuss an additional benefit of doing a Bull Call Spread instead of buying just a call option when the issue you are considering has high volatility. If you purchase a call option on an asset that has high volatility, the asset price could go up, as you expected, yet at the same time, the option price could drop if the implied volatility of the asset declines significantly during that time. So although you were right about the directional movement of the asset, you would have lost money in a straight call option play. A Bull Call Spread could ameliorate that risk, because it is the spread between the call option prices that determines your profit. The call that you sold would also go down in value as volatility declined, but the spread between the call prices would increase as the price of the underlying asset increased. That would give you a profit instead of a loss.

It is also important to cover risks and caveats of this strategy.

The risk of this position is limited and known as described above. Remember that the commission you pay for this position will be higher than the commission for a straight option play, because you are initiating two related option transactions.

When you initiate a Bull Call Spread rather than outright purchase of a call, you are limiting your upside potential. If the asset price rockets skyward, then you aren't able to fully participate in that gain because the higher strike price call that you sold will probably be exercised, limiting your gain.

The major benefits of this strategy occur when volatility is high, making the purchase of calls expensive and increasing the risk of a drop in volatility.

It is important to analyze your expectations for the underlying asset and for the market before selecting your strategy.

source: www.mindxpansion.com
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