Spread refers to the difference between the higher and lower strike price. Bull call spread and bear call spread both are multi-leg strategies (involving two or more options) which are used when the investor has a moderate outlook (moderately bullish or moderately bearish) for the stock or index or market. A moderate outlook can be based on a fundamental, technical or quantitative perspective. For instance, merger or acquisition, annual results announcements, and technical charts can be the reason for a moderate outlook by an investor.

**BULL CALL SPREAD**

It is one of the most popular strategies used by investors. Bull Call Spread is used when the investor has a moderately bullish outlook. It involves two options: At the Money and Out the Money Options.

**At the Money Option (ATM)**: Option with a strike price less than the spot price.

**Out the Money Option (OTM)**: Option with a strike price more than the spot price.

Here, it is important to ensure that both the options have same underlying asset, the same expiry and the same number of options.

For example, If the spot price is Rs 846, then AT The Money option is the option with a strike price less than Rs 846 (say Rs 800) and out the money option is the option with a strike price more than Rs 846 (say Rs 900).

For implementing the bull call spread strategy, the investor needs to

1) BUY an At the Money Call Option and

2) SELL one Out the Money Call Option.

It is important to know that while buying the call option, the investor will pay a premium whereas while selling the call option, the investor will receive the premium. Also remember that the fair value of the option will be the difference between the Spot price and the Strike Price (if Spot the strike is negative, the fair value would be considered as zero).

Let’s continue with the example mentioned above. Say the premium paid on the ATM option is Rs 29 and the premium received on the OTM option is Rs 15. Now, the net premium paid is Rs 14 (29-15) which is the cost of implementing this strategy.

Further on or before expiry, there can be different scenarios or cases:

__Case 1____: Spot price below the strike price of ATM Option__

Spot price: Rs 700

Now, the value of ATM Option is Rs -100 (Rs 700 – RS 800) which will be considered as zero. Similarly, value of OTM Option is also zero. It simply means both options will expire without any realization.

Therefore, Net Payoff (LOSS) will be Rs 14 (Net Premium Paid by the investor) as the options did not realise any benefit for the investor.

__Case 2____: Spot price at the strike price of ATM Option__

Spot Price: Rs 800

Again, the value of ATM Option and OTM Option is zero (Rs 800 – Rs 800 and Rs 800-Rs 900 respectively.

Therefore, Net Payoff (LOSS) will be Rs 14 (Net Premium Paid by the investor) as the options did not realise any benefit for the investor.

__Case 3____: Spot price above the strike price of ATM Option and up to the strike price of OTM Option__

Spot Price: Rs 900

Now, the value of the ATM Option is Rs 100 (Rs 900 – RS 800) and the value of the OTM Option is zero again which simply means that the strategy generated a profit of Rs 100 for the investor.

Therefore, Net Payoff (PROFIT) will be Rs 86 (Rs 100- Rs 29+ Rs 15)

__Case 4____: Spot Price above the strike price of OTM Option__

Spot Price: Rs 950.

Now, the fair value of the ATM Option is Rs 150 (Rs 950 – RS 800) and the value of the OTM Option is Rs 50 (Rs 950 – Rs 900). However, the value of the OTM Option is a loss for the investor as the investor has already sold the OTM Option.

Therefore, the Net Payoff (PROFIT) will be Rs 86 (Rs 150- Rs 50- Rs 29+ Rs 15).

**Summary: **

**Spot Price = **Rs 846

**ATM Option - **Buying ATM Call Option of Rs 800 at Rs.29 Premium.

**OTM Option – **Selling OTM Call Option of Rs. 900 and Receive Rs.15 Premium.

**Now Profit and Loss in Different Scenarios if the Stock Price After One Month is as follows:**

Final Price | Value of ATM | Value of OTM | Net Premium Paid | Net Payoff |

700 | 0 | 0 | -14 | -14 (LOSS) |

800 | 0 | 0 | -14 | -14 (LOSS) |

900 | 100 | 0 | -14 | 86 (PROFIT) |

950 | 150 | -50 | -14 | 86 (PROFIT) |

It can be noticed that in this strategy both the upside and downside risk is limited i.e., both potential profit and loss is limited. In the given example, potential loss is limited to Rs 14 (Net Premium Paid) and potential profit is limited to Rs 86 (difference between Spread and Net Premium Paid).

**Maximum Profit will be = **

Difference between the Strike Price of both options Less Net Premium Paid (Premium Paid – Premium Receive)

**Maximum Loss will be = **Net Premium Paid

For other interesting conceptual topics please visit our other contents:

Bear Call Option Strategy: __https://www.thenumbernews.com/post/option-strategy-bear-call-spread__

Basics of Futures & Options: __https://www.thenumbernews.com/post/futures-options__

How to hedge Foreign Exposure: __https://www.thenumbernews.com/post/how-to-hedge-foreign-exposure__

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