What it means
Options are contracts giving the holder the right, but not the duty, to buy or sell a share at a set price before a set date. A bull vertical spread pairs two of them on the same underlying share with the same expiry date but different strike prices, one bought and one sold.
The word vertical simply refers to the two strikes sitting one above the other in a column on a broker's options screen. There are two standard builds and both profit from a rising price.
A bull call spread buys a call at a lower strike and sells a call at a higher strike, so the trader pays a net amount upfront, known as a debit. A bull put spread sells a put at a higher strike and buys a put at a lower strike, so the trader receives a net amount upfront, known as a credit.
The appeal for most users is defined risk. The premium collected on the option that is sold pays for part of the option that is bought, which cuts the cost of entry and the worst-case loss, while that sold option also caps the gain above its strike.
Finance teams use the same shape when they want exposure to a price move inside a budget that has already been signed off. In practice the two strikes are chosen around a real view on the price.
The lower strike usually sits close to where the share trades now, the higher strike close to the trader's target, and the gap between them sets the maximum payoff. The net premium then sets the break-even price, which is the level the share must reach before the trade turns profitable.
The trade-offs are easy to miss. Because the upside is capped, a spread will badly underperform a single long call in a sharp rally, and it still loses money if the share simply drifts sideways until expiry.
Two legs also mean two lots of dealing costs, and the option that was sold can be exercised against the trader early when the contract is on an individual company's shares.
In practice
Real-world examples.
Example
A private investor believes a listed software company will rise from $48 to around $60 after its next results, but does not want to risk the $400 a single call would cost. She buys the $50 call and sells the $60 call for a net $250, accepting that she gives up anything above $60 in exchange for cutting her maximum loss by $150.
Example
A metals buyer at a cable manufacturer expects copper to rise and wants cover without an open-ended premium bill. He puts on a bull call spread on a copper futures contract, so the finance director can see a fixed worst case of $18,000 rather than an unknown one.
Example
A boutique fund manager is mildly positive on a broad market index and wants income rather than a lottery ticket. She sells a put at the money and buys a lower-strike put, collecting a credit of $1.20 per share that she keeps in full if the index holds its level to expiry.
Formula
Calculation
For a bull call spread:
Net debit = premium paid on the lower strike call - premium received on the higher strike call
Maximum loss = net debit
Maximum profit = (higher strike - lower strike) - net debit
Break-even share price = lower strike + net debit
Worked example. A share trades at $48. The trader buys one $50 call for $4.00 per share and sells one $60 call for $1.50 per share, with each contract covering 100 shares.
Net debit = $4.00 - $1.50 = $2.50 per share, so $250 for the contract.
Maximum loss = $250, which happens if the share closes at or below $50.
Maximum profit = ($60 - $50) - $2.50 = $7.50 per share, so $750.
Break-even = $50 + $2.50 = $52.50.
If the share closes at $65 at expiry, the spread is worth the full $10 per share, or $1,000, and the profit is $1,000 - $250 = $750.Case study
Seen in the real world.
In this illustrative, entirely fictional case, Harborline Instruments is a mid-sized maker of marine sensors whose board has approved a small, ring-fenced hedging budget after a bruising year of raw material swings. The treasurer expects the shares of a listed supplier the company part-owns to recover from $48 towards $60 once a contract award is announced, and she wants to benefit without asking for more capital.
She buys 20 of the $50 calls and sells 20 of the $60 calls, paying a net $5,000 in total, which is exactly the limit the board set. When the award is confirmed and the shares reach $64, the spread is worth $20,000 and Harborline books a $15,000 gain. Her written note to the audit committee stresses the other outcome: had the contract gone elsewhere and the shares stalled at $47, the loss would have been the $5,000 and not a penny more.
Watch out
Common mistakes.
- Assuming the trade is risk-free because the loss is capped. A bull vertical spread can and often does lose the entire net debit when the share price fails to rise.
- Choosing strikes that are far too wide apart, which turns the position into something close to an outright long call and removes most of the cost saving the structure exists to deliver.
- Forgetting that the option sold can be assigned before expiry, leaving the trader with an unexpected share position and a margin call over a weekend.
Questions
People also ask.
Does a bull vertical spread need the share price to rise a lot?
No, it only needs to rise past the break-even price, and the maximum profit is reached once it clears the higher strike, so a modest move is enough.
What is the difference between a bull call spread and a bull put spread?
The call version is paid for upfront and profits as the debit turns into intrinsic value, while the put version is paid to you upfront and profits by the options expiring worthless.
Can the maximum profit be worked out before placing the trade?
Yes, it is the gap between the two strikes less the net debit, which is why these trades suit anyone who has to state a worst case and a best case in advance.
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