What Is a Bull Spread and How Does It Work?

In a bull market, stocks are trending upwards, and investors are often trying to place trades that would benefit from rising prices. Option strategies have defined parameters that allow you to express specific views on the markets.

An option gives you the right but not the obligation to buy or sell an underlying asset at a specific strike price on a future expiration date. Although options are tradable on many assets, the article covers options by stocks and how to trade bull spreads using options.

Understanding Bull Spreads

Investors with a bullish view that expect somewhat limited price increases might use bull spreads to potentially profit from rising prices. Bull spread trades can be placed using calls or puts. 

A call option gives the buyer the right to buy a stock at the strike price by expiration, and a put option gives the buyer the right to sell a stock at the strike price by expiration. The cost of the option is the option premium.

In a bull spread trade, you choose different strike options to buy and sell, which changes the premium paid or received. Combining options allows you to express specific views on timing and price action.

How the Bull Call Spread Works

A bull call spread involves buying a lower strike call and selling a higher strike call option that expires on the same date. 

Let’s say you expect the price of Apple stock to rise within the next two months, but not substantially. If the stock is trading at $100, you might pay $4 for a $105 strike call option and sell a $110 strike call and collect $2. Both expire in two months.

Formulas for Bull Call Spread

The defined parameters of bull spreads mean that you can calculate scenarios like maximum profit and loss using formulas.

Theoretical Maximum Profit and Loss

Your maximum profit occurs when the stock rises to the strike price of the short call option at expiration.

Maximum profit = short call strike price - long call strike price - long call premium + short call premium

Maximum loss occurs when the stock trades below the lower (long) call strike price at expiration. It is the net option premium paid.

Maximum loss = long call option premium - short call option premium

Example of Using Bull Call Spread

You may consider using  a bull call spread if buying the lower strike call is expensive and you don’t expect the stock price to rise much above the upper call strike price. Or perhaps you are willing to give away upside above the upper call strike price to fund the option premium you have to pay.

In the example with the Apple stock, your maximum loss is the net premium paid to setup this position, which is $200, ($2*100=$200). Your maximum profit is the difference between the strike prices minus the net premium, which in this case is $300, ($3*100=$300) for the spread.

How the Bull Put Spread Works

A bull put spread involves buying a lower strike put option and selling a higher strike put option that expires on the same date.

Let’s say you expect the price of Apple stock to rise within the next two months, and you believe it will not fall below the lower strike price. If the stock is trading at $100, you might pay $4 for a $95 strike put option and sell a $98 strike put and collect $6. Both expire in two months.

Formulas for Bull Put Spread

After you choose your strike prices and understand the option premium costs, you can easily calculate your maximum profit and loss on the trade.

Theoretical Maximum Profit and Loss

You collect maximum profit when the stock stays above the strike price of the put option. It is the net option premium received.

Maximum profit =  long put premium + short put premium

Maximum loss occurs when the stock trades at the lower (long) put strike price. 

Maximum loss = (higher strike price - lower strike price) - (long put option premium + short put option premium)

Example of Using Bull Put Spread

If you think that Apple stock will not fall in the next two months, you may consider selling a put spread expiring in two months. In the $200 ($2*100=$200) previous example, your maximum profit is the net option premium collected, which is $2 per contract.

Possible Advantages of Bull Spreads

Bull spreads allow you to express specific trading views and have the following advantages:

• Limited risk: Your theoretical maximum loss on bull call spreads is the premium paid to buy the options.
• Alternative positioning: Instead of putting on a long position that could risk loss,of owning the stock your maximum loss is calculated according to the options strategies.
• Flexibility: You can choose the strike prices and customize the option strategy according to the risk you’d like to take.

Things to Consider with Bull Spreads

Before putting on a bull spread, traders should consider the following factors:

• Expiration: The options will expire and will lose their value as they get closer to the expiration date.
• Limited profit: Bull spreads have limited risk because they have limited profit potential. 

Discover Bull Spread Strategies 

Bull spreads allow traders to express very specific views on the timing and price direction of the underlying asset. You can choose strike prices depending on what levels you think a stock will trade at by its expiration date and adjust your maximum profit and loss accordingly.

Frequently Asked Questions