What it means
The most common version is the bull call spread. You buy a call option at a strike near the current price and at the same time sell a call at a higher strike, collecting a premium that partly offsets what you paid.
The result is a position with a known maximum gain, a known maximum loss and a lower entry cost than simply buying a call outright. What you give up is everything above the higher strike, and that surrendered upside is the price of the cheaper entry.
There is also a bull put spread, built by selling a put at a higher strike and buying a put at a lower one, which brings in a net credit at the outset. The payoff shape is much the same, and the difference is mostly about cash flow timing and how margin is treated.
Businesses meet bull spreads less often on a trading desk than in commodity hedging. A manufacturer worried about copper or fuel prices rising can use a call spread to cap its exposure between two price levels far more cheaply than buying outright protection.
The main nuance is that the cap is real and binding. If the underlying price runs far past the higher strike, the extra gain belongs to whoever bought the option you sold, which is exactly why the strategy suits a view of a modest rather than unlimited rise.
In practice
Real-world examples.
Example
A cable manufacturer expects copper to rise modestly over the next quarter and buys a call spread on copper futures. The cap costs it a fraction of an outright call, and it accepts that a sudden price spike beyond the upper strike would leave part of its exposure unprotected.
Example
A private investor is mildly positive on a supermarket group ahead of results. Rather than pay a full call premium on a share she thinks will move only a few per cent, she builds a bull call spread and cuts her outlay by more than half.
Example
A treasury team wants exposure to a recovery in an equity index without committing much capital. It uses bull put spreads to bring in premium income each quarter, accepting a capped and clearly defined loss if the index falls through the lower strike.
Think of it
“Bull spread bets on moderate upside-a cheaper way to profit from stock going up.
Formula
Calculation
For a bull call spread:
Net cost = premium paid on the lower strike call - premium received on the higher strike call
Maximum profit = (higher strike - lower strike) - net cost
Maximum loss = net cost
Breakeven price = lower strike + net cost
A trader expects a share currently at $51 to drift higher over three months. She buys a call with a $50 strike for a premium of $4.00 a share and sells a call with a $60 strike for $1.50 a share, so the net cost is $4.00 - $1.50 = $2.50 a share. Options trade in contracts of 100 shares, so one spread costs $2.50 x 100 = $250.
Maximum profit is ($60 - $50) - $2.50 = $7.50 a share, or $750 per contract, reached at any price of $60 or above. Maximum loss is the $250 paid, suffered at any price of $50 or below, and the breakeven is $50 + $2.50 = $52.50.
If the share finishes at $58, the $50 call is worth $8.00 and the $60 call expires worthless, so the profit is $8.00 - $2.50 = $5.50 a share, or $550 per contract. Buying the $50 call alone would have paid $8.00 - $4.00 = $4.00 a share, so in this case the spread earned more for less money at risk.Case study
Seen in the real world.
The following is a clearly fictional, illustrative example. Alder Brewing, an invented craft brewery, buys around 4,000 tonnes of malting barley a year and had been buying outright call options to protect itself against price rises. The premiums were consuming an uncomfortable share of its hedging budget.
In the illustrative scenario, the finance manager reviewed ten years of price behaviour and concluded that big single season spikes were rare, while moderate rises were common. He switched to call spreads capped a fifth above the current price, which cut the annual premium bill by roughly 60% for the same lower strike.
Two years later a genuine supply shock pushed barley well beyond the upper strike and Alder's protection ran out part way up. The fictional board reviewed the policy and kept it, judging that the premiums saved in ordinary years more than covered the one year in which the cap bit.
Watch out
Common mistakes.
- Forgetting that the upside is capped, then treating a bull spread as if it were an outright bullish position when sizing the trade.
- Quoting the profit per share rather than per contract, which understates the real position by a factor of 100 in most markets.
- Ignoring dealing costs and bid-offer spreads on two legs rather than one, which can matter a great deal on a small position.
Questions
People also ask.
When is a bull spread better than simply buying a call?
When you expect a limited rise, because the premium you collect on the sold leg lowers your breakeven and your cost, at the price of giving up gains beyond the upper strike.
What happens if only one leg is exercised early?
You can end up holding an unintended position in the underlying, which is why traders monitor spreads closely as the sold leg moves deep into the money.
Is a bull spread suitable for hedging a business cost?
It can be, where the business wants affordable protection against a moderate price rise and can live with exposure above the upper strike.
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