A bull call spread is constructed by buying an in-the-money (ITM) Call Option and selling another out-of-the-money (OTM) Call Option. Often, the Call with the lower strike price will be in the money while the Call with the higher strike price is out-of-the-money. Both Calls must have the same underlying security and expiration month.
The net effect of the strategy is to bring down the cost and breakeven on a buy/long Call strategy. This strategy is exercised when an investor is moderately bullish to bullish because the investor will make a profit only when the stock price/index rises. If the stock price falls to the lower (bought) strike, the investor makes the maximum loss (cost of the trade), and if the stock price rises to the higher (sold) strike, the investor makes the maximum profit. Let us try and understand this with an example.
The Bull Call Spread Strategy has brought the breakeven point down. If only the Rs. 4100 strike price Call was purchased, the breakeven point would have been Rs. 4270.45. This reduction in the breakeven point reduces the cost of the trade as well. If only the Rs. 4100 strike price Call was purchased, the cost of the trade would have been Rs. 170.45. Additionally, the strategy mitigates the potential loss on the trade. If only the Rs. 4150 strike price Call was purchased, the loss would have been limited to Rs. 170.45, which is the premium of the Call purchased. However, it's important to note that the strategy also comes with limited gains and is therefore ideal when markets are moderately bullish.
