The Bull Spread

The bull spread focuses on a slight increase in the value of the stock that the option is being applied onto. This is a simple process:

1. You will place a long call on an option with a lower strike total.
2. You will then pair that first call with another short call for a higher strike value. You would buy the long call and sell the short call at this juncture.
3. The two calls are made with the same expiration date.

You can also work with put options through this process if you prefer. This will be discussed in the next section of this chapter. Your goal is to get the stock to move between the low and high-strike prices. The general move is to minimize any risks that you have in the investment process. It helps to work with upward and downward-trending processes. The long call will keep the risk of the short call from being significant. The profit of your bull spread will increase when the stock’s price moves up toward the strike value of the short call option. You would lose money if the value of the stock drops, but the losses will at least be kept in check when the price is under the long call’s strike price.

While the limits on your losses are useful, you will also be limited to how much you can earn. The maximum amount that you will earn is when your stock goes beyond the underlying strike price. Therefore, you should aim to get the price over the low-strike price so the losses will be kept to a minimum. You would not benefit much when a stock skyrockets in value either. Then again, you are not going to experience massive losses if the stock suddenly plummets in value. To get a better idea, it helps to understand how this might work:

1. You might find a stock trading at $30.
2. You would buy a long call at $35.
3. You will also sell a short call option with a price of $40 with a value of $400 attached to it.
4. If the price moves to $45, you will have to give 100 shares of the stock at $40 as part of the short call.
5. The purchased call lets you buy the shares at $35 and then sell them for $40. This works better than buying the stock at the $45 rate and selling it at a loss.

This should provide you with a sizable profit on the investment. You would have to look at how the transaction moves and see what you would realize from the bull option. The profit would be the difference between the two options ($5) times the number of shares you bought times 100 (this would be $500) minus the total cost that you would spend on the shares at the highest value ($400). In other words, you could realize a profit of $100 in this example. Overall, the profit will increase when the stock’s value goes up toward the value of the short call option. The premium being paid is the highest possible loss you would experience.

This is important because the bull option is designed to be used when you feel a stock is going to move up by a slight amount. You are not necessarily going to get a huge profit if the stock price moves a lot. Then again, it is not as though you are going to see a decline in the profit either.