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Bull Call Spread Option Strategies - Options Trading Strategies - Bullish Options Strategies - YouTube
Channel: Option Alpha
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Hey everyone, and welcome back to Option Alpha.
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This is Kirk, here again.
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And we're talking about the option strategy
bull call spread here.
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So, we'll get right into it here as always,
taking a look at the market outlook for this
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type of a strategy, when you would really
place this type of a strategy as far as your
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trading arsenal.
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So, the bull call spread strategy is really
going to be employed and used in the market
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when you see some moderate increases in the
underlying stock.
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So, not a huge breakout in the underlying
stock, we're not talking about a 10% to 15%
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move, we're talking about maybe a 2%, 3%,
5% move in the underlying stock higher.
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So again, we are talking about a bull call
option, so it's going to be a bullish strategy
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overall.
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You want the market to increase.
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But what's really different about this type
of a spread is that you are not really, really
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that excited about the stock.
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You don't think it's going to go higher, so
you're actually going to substitute one of
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your upside potentials (being the long call)
by selling an out-of-the-money call as well.
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So, this is where we get this strategy that
has two different options that are involved
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in it, and we'll talk about this later in
the video.
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But you're going to sell some of the upside
potential and give up some of that upside
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potential for the opportunity to get back
some of your premiums.
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So, it's going to be a little bit cheaper
strategy overall, but you're going to give
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up again, some of that upside potential.
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When we talk about how to set up this type
of a strategy, a bull call spread is really
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set up by buying one in-the-money call, and
then selling one out-of-the-money call on
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the same security on the same month.
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So again, if we look at our chart here, we're
going to buy one in-the-money call, and let's
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say we're going to buy for example, this $40
strike.
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So, that's where our first call option is
going to pivot here on this graph.
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And then at the same time, we're going to
simultaneously sell one call option at a strike
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price of $45.
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So, that's how we have two of these kind of
pivots or directional movements in the profit
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loss diagram here.
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And that's how you really build this bull
call spread.
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Just two simple options: You're going to buy
an in-the-money call, and then sell an out-of-the-money
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call right around the market underlying price.
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So, what's the risk for this type of a strategy?
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Well, it's pretty simple.
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The max loss is limited to the debit, so you're
actually going to outlay some money for this
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call.
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And then, when you go and you sell the out-of-the-money
call, it's going to be a little bit cheaper
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and you're going to still incur a debit or
it's going to cost you money to get into this
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trade.
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You're actually buying the overall spread.
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You're not getting a credit.
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So, your max loss is limited to just that
debit.
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If the market were to absolutely crash after
you initiated this trade, well, then you would
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only lose your initial investment, and let's
say that's $200 overall.
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So again, the worst that can happen is that
the stock can close below the lower strike
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at expiration.
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In which case, both of these options would
expire completely worthless, and you'd simply
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be left with your debit as your max loss.
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So again, a very limited risk type of a strategy,
which is why people like it.
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So, let's talk about profit potential now.
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Again, as the same thing that we have limited
risk on the downside, we're also giving up
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some of that unlimited profit potential on
the top side.
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So, this position in this strategy does have
a capped game.
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It's limited to a certain amount of gain in
the underlying security.
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So, if the stock closes at or above the short
call strike, which in this case is 45, then
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you can capture that maximum difference in
premium and pricing.
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And anything above 45, you'd still capture
the same amount of money.
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So again, this is different than a call option
where we start to really start to see incremental
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gains in our underlying value.
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Anything above 45 where that short strike
is on that call, you're going to be capped,
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as far as how much you're going to earn.
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And then obviously, anything between the strike
prices, so anything closing between 40 and
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45 is going to be resulting in a variable
gain or loss, depending on where you end at
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expiration.
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Volatility risk for these positions is actually
fairly low.
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There's a little bit of volatility risk, just
because you do have different option strikes,
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so you're going to have different types of
reactions to volatility.
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But since you're long a call and short a call,
the effects are really going to offset each
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other to a really large degree.
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Time decay is going to be virtually the same
thing for this type of position as well.
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Since you're long a call and short a call,
the effects of time decay on your long call
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are going to be completely offset by the positive
effects of time decay on your short call.
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So again, as we get closer to expiration now,
this deadline for achieving a profit is going
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to result in you having to make a decision.
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Since this is a debit position and you did
outlay money for it, you're going to have
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to see a profit or else, that profit is going
to dwindle away at expiration.
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So, there is a little bit of time decay risk,
but it's not a great time decay risk.
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You can still make a trade.
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The market can move around or move sideways
and then move later on.
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And you're not going to have a real big risk
of making a quick decision on this type of
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a trade.
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So, breakeven points: This is important to
calculate with these bull call spreads.
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The strategy breaks even in expiration if
the stock price is above the lower strike
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by the initial amount of the debit.
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So again, if we traded the initial strike
price of long call at $40 and we outlaid $200,
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then we would want to see the stock at least
go up $2, so that we can capture our premium.
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You can see that this is where our profit
loss diagram crosses over here on this chart.
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It's right at 42 which is the $40 strike,
plus our cost or our debit, to enter the position
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of $200.
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And so, that's going to equate to about a
$42 strike price on the chart.
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So again, it's the long call strike, plus
the net debit that we received.
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That's going to be our breakeven point.
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So, as you're starting to look at charts,
and if you enter this position and calculate
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your breakeven, you're going to want to see.
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Is it really possible for the stock to make
that type of a move, or is there some resistance
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that could be impeding that type of a move
on a stock chart?
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So, if you start to see that your breakeven
point is much higher than you thought before,
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and you think it can definitely get above
40, but maybe not above 42, then you might
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want to reconsider entering the strategy of
course.
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So, some of my tips and tricks for the bull
call spread: Obviously, the more out of the
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money your strike prices are, the more bullish
you're going to be.
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You don't necessarily have to enter the first
strike in the money.
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You can enter the first strike out of the
money.
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So again, using this chart is our example.
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Let's say that the market is actually trading
at 35 right now.
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Your first strike could be a 40 strike, which
is actually out of the money to begin with.
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Now, these cheaper debits doesn't necessarily
mean that you have a better position.
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Just because the price is cheaper doesn't
necessarily mean that you're going to make
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more money or that it's an easier position.
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The price being cheaper means that it's less
likely that it could move higher, and you
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will be compensated if it does.
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So, you're taking on more risk.
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Cheapness and option strategies does not necessarily
mean better.
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Now, if you're having trouble filling these
positions, try legging into the spread.
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I know a lot of people who try to fill with
these positions, and it's really tough because
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you do have to enter both sides of the spread
exactly at the same time in the market.
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So, why not try to buy or sell just one single
leg of the option spread, and then come back
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in later and reenter the other one?
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So, for example: you would buy the 40 strike
call first, let that order get executed, and
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then come back in later and resell the 45
strike call.
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Again, completing your spread at the end of
the day, but it's a lot better way to get
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into the market at better prices.
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And legging in is always a good option if
you can't get fills.
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Hey, thanks for watching this video from Option
Alpha.
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As always, we invite you guys to come back
and check us out at optionalpha.com.
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