A Bull Call Spread involves buying a call option and selling a call option with a higher strike within the same expiration month.
• Cost Basis Reduction: Call Spread allows Cost Basis Reduction. This is the main reason why you want to trade verticals (spreads with different strike prices in the same expiration term).
• Moderate Upward Movement: It is executed when the general feeling towards an asset is positive and a moderate upward movement is expected. Suppose you are bullish on the Stock and expects it to move upwards but not in a rapid fashion, then you can trade Debit Call Spread.
• Low Risk, Low Reward and Lower Requirements: Debit Call Spread involves low Risk, has low Requirements and will provide low Reward.
• Exchanging Upside Potential for Chance to Recover Premium: This higher Probability of Success compared to Long Calls is the most important aspect of Debit Call Spread. Here you will not only have a cost basis reduction, but also a higher Probability of Success compared to trading Calls.
When you start trading options, you might be able to trade only in Puts and Calls as your broker or dealer might not give you enough rights to trade vertical spreads. But once you get more experienced and understand the concept of Probability of Success, you can ascribe for Cost Basis Reduction as you are buying calls and selling out-of-the-money calls in Debit Call Spread. By selling OTM calls with higher Strike Price Call, you can reduce the cost basis compared to when buying a call outright. And by reducing the cost basis, you can increase the probability of being correct.
• Buy In-The-Money (ITM) Call Option with lower Strike Price, because you have a bullish bias for an underlying asset.
• Sell Out-of-The-Money (OTM) Call Option with a higher Strike Price.
• Use the same underlying asset and the same contract Expiration Date based on forecast accuracy. You have to pick an Expiration Date that gives you the highest chance of success. Based on our research at Tradespoon, the best duration for Option contract is between 50-75 days. In order to achieve higher Probability of Success with options, you want to pick 50-75 days till expiration. This will afford you more time to be correct on your bias for the stock.
• Select Strike Prices based on Probability of Success, and Tradespoon’s analytics such as the Probability Calculator or the Stock Forecast Tool.
In Figure 13, x-axis denotes the stock price and y-axis denotes the Profit/Loss. Point A denotes the buying price and Point B denotes the selling price, which are the Strike Price selections. The Expiration Month is again 50-75 days. Maximum Loss will occur at Point A, meaning that if you are wrong and the stock drops to lower than point A, you will lose money. Maximum Gain occurs at Point B.
The Breakeven Point is the Debit Price you paid and is indicated by the point where the blue line intercepts the x-axis. This example is of a directional trade with bullish bias.
Return on Capital
Return on Capital determines at what point you get into a position and at what point to get out of the position.
• With Bull Call Spreads, you pay the cost of the Long Call (In-The-Money Option) and you earn proceeds from the sale of Short Call Option (Out-of-The-Money Option).
• Total trading costs is the difference between the amounts paid and earned under maximum Risk.
• Maximum Gain is the difference between the two Strike Prices (B-A) minus the original Debit paid.
• Maximum Loss will be the original Debit paid which is the sum of (A) and the premium paid for the Debit Spread.
• Breakeven Point is the position where maximum loss can occur and is at the point of intersection of the blue line on the x-axis.