The bull call strategy can be used to profit in uptrending markets with relatively low risk and involves purchasing a call option while simultaneously selling a call option at a higher strike price and typically in the same month. For example, if you liked POT stock at $120 per share but couldn’t afford to purchase the stock you might decide to purchase a long call option.
With time-decay so potent during the first month and with a preference to take a less active role in your trading you may wish to purchase a March strike 120 long call. To your disappointment you find the long calls in March at strike 120 cost $16.10 at the current Ask price. So what could you do?
Perhaps enter a cheaper trade, a bull call spread, using the same long call at strike 120 but also incorporating a short call at strike 130, which generates a credit of $11.60. Now the overall cost of entering the spread is $4.50, a substantial cost reduction from simply purchasing a long call alone. The maximum reward is limited to the difference in the strike prices of the options minus the debit spent.
Maximum Reward = $10 – $4.50 = $5.50
Maximum Risk = Cost Basis = $16.10 – $11.60 = $4.50
These trades might appear attractive on first viewing. After all if the stock goes up a potential 100%+ profit is on the cards. But new traders can often be shocked that the trade is often nowhere near as attractive as initially expected when the stock rises after trade entry.
Associated with each option is a delta figure which tells the trader how much the options will move as the stock moves $1. For example, the long call delta for strike 120 March options on POT is 0.58 while the short call delta at strike 130 is -0.48. This means that combining the two deltas together for the spread yields a delta of of 0.10 (0.58 – 0.48). This tells the trader that as the stock rises $1, the bull call increases in value by just $0.10.
Suddenly, the trade seems a whole lot less attractive because in practice you will also find commissions and slippage have an impact. So is there any way to take advantage of these bull calls?
One way to take advantage of this bull call spread is to enter a trade that, on the face of it, seems even worse!! How so? If you were to move from March options to January 09 options, the long call delta increases to 0.65 but the short call delta is -0.60. This means the trader makes only $0.05 as the stock goes up every $1. Obviously this seems like a much less attractive trade.
But what if we find a stock that we like and that we believe will find support by January 09 at a certain level, could we find a way of exploiting this low position delta?
For example, let’s assume we like NYX trading at $86.60 and believe it is unlikely to trade below $85 per share by January 09. We could simultaneously purchase a long call at strike 80 and sell a call at strike 85. The long call costs $18.85 and the short call produces a credit of $15.85. Thus the cost of the trade is $3.00 which is also the risk.
The reward in the trade is $2.00 ($5.00 difference in strike prices minus the debit). The position delta is highly unattractive, sitting at just 0.06. But it is only unattractive if you are looking for a quick gain, in and out. If you decide that you want to make a return of 60%+ on your capital in the next 411 days then this type of trade becomes very appealing.
The trade requires virtually no work. The same reason the trade doesn’t make much money initially if the stock goes up (the small position delta) is the same reason the trade doesn’t lose much money if the stock drops somewhat in the interim. It’s a nice trade to have in your virtual portfolio if you want to sit back, ride out market volatility and yet still have the potential to make some handsome returns in just over a year.
For those of you that love to get in and out quickly and love the excitement and volatility of the game, this trade will not keep you interested! But as Phil mentioned, sometimes the name of the game is to "Just Stand There" and "Do Nothing". Getting in and out often can be costly unless you are really piling on those profits and learning to sit patiently is always productive in learning to trade successfully.
Have a fantastic week!
OptionSage
