Thinking about trading options to capitalize on stock price appreciation? If your approach involves multiple options, it’s likely to be a bull spread. These spreads are a type of vertical options spread that anticipates a future increase in the price of an underlying asset. The positive sentiment makes it bullish, and the involvement of multiple options makes it a spread.
There are different types of bull spreads. And options traders have a lot of variability in how they set them up. At their core, however, they’re relatively similar. They involve simultaneously buying and selling put and call options with different strike prices. Doing so creates the “spread,” a range where the investor knows their risk, reward and break-even points upfront.
Here’s a closer look at bull spreads: how to set them up, how they work and what traders can expect when they dabble with bullish options.
Establishing Bull Call vs. Bull Put Spreads
In setting up bullish options spreads, traders can take one of two approaches: put spreads or call spreads. Both are bullish, which means they capitalize on positive price movement. However, what differentiates them is the structure of the spread (call vs. put).
- Bull call spreads are debit spreads because the purchased option costs more than the sold option. In these spreads, the trader buys a call option with a strike price above the current share price. They will then write a call option for an even higher strike price. With a bull call spread, the investor seeks to make money in the future, on the appreciation of the stock.
- Bull put spreads are credit spreads because the purchased option costs less than the net income from the sold option. Here, the trader purchases a put option with a strike price above the current price. Then, they write another put option for an even higher strike price. With the bull put spread, the investor brings in money upfront.
What really makes these spreads different is the timing of cash flows. Both capitalize on price appreciation. And both reach their maximum potential if the underlying asset price closes at or above the higher strike price. Traders choosing bull call spreads will make their money back when the options land in the money. Those with bull put spreads seek to hang on to the credit they receive in setting up the spread.
How to Profit on Bull Spreads
No matter what type of bull spread a trader engages in, the outcome of the underlying security price needs to be positive. If the price of the underlying asset doesn’t appreciate, the bullish options will expire worthless. That means the options are out of the money if they close under the low strike price. Likewise, both spreads maximize profits if the underlying asset price closes above the high strike on expiration.
It’s also important to pay attention to break-even points for spreads. In a bull call spread, the break-even point is the lower strike price plus the net premium paid. In a bull put spread, the break-even point is the upper strike price minus the net premium received.
When to Use Bull Spreads
As the name implies, these spreads are best-used in generally bullish markets. If you believe the price of a stock is going to rise incrementally in the near future, these spreads are ideal. They’re great for creating controlled, profitable spreads following the identification of bullish trends.
For example, investors can identify support and resistance points within a bullish trend to hypothesize appropriate prices for buying and selling options. In more aggressive bull markets, a wider spread might yield more opportunity for profits. And in uncertain or faster-moving bull markets, tighter spreads can target more specific levels.
Mitigate Risk, Cap Reward
The appeal of this spread is the known risk-reward relationship that’s created by the strike prices. By capping risk and reward, investors put themselves in a position to speculate in a bullish capacity. This is often why investors will stagger these spreads as they identify different support and resistance levels in an emerging trend. They can establish more conservative or aggressive spreads depending on trend strength.
The Pros and Cons
Bull spreads tend to be among the safer options strategies out there. This is largely due to their simplicity and controlled nature. As a result, they have well-defined pros and cons that any trader, new or seasoned alike, can keep in mind.
Pros:
- Investors know potential losses upfront, and they’re mitigated.
- Bull spreads are broadly applicable (and profitable) in bull markets.
- Maximum reward is known and defined upfront.
Cons:
- Investors face capped maximum gains (higher call strike price).
- Risk of early exercise options by short-call buyers (bull calls).
It’s also important to realize the these spreads don’t work well in aggressively bullish markets. Because the high strike price in a bull spread effectively caps the potential for ROI, fast-moving prices can leave spread traders behind.
The Bottom Line on Bull Spreads
Optimistic investors who think the price of a security will increase incrementally in the short term can use options to create parameters for profitability. Bull spreads depend on rising prices, and they allow traders to set very specific ranges for profiting off of it. With credit and debit spreads, traders can also control their cash flow with bullish options.
Just make sure you’re not trying to catch lightning in a bottle! A fast-moving, highly volatile security doesn’t lend itself to bull spreads. These spreads are best-used in stable, up-trending markets.