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 this strategy is to reduce the cost and lower the breakeven point of a long Call strategy. This strategy is used when an investor is moderately bullish, as profit is made only if the stock price or index rises. f the stock price falls to the lower (bought) strike, the investor incurs the maximum loss (cost of the trade). Conversely, if the stock price rises to the higher (sold) strike, the investor achieves the maximum profit. Let us try and understand this with an example.
The Bull Call Spread Strategy lowers the breakeven point. If only the Rs. 4100 strike price Call was purchased, the breakeven point would be Rs. 4270.45. This reduction in the breakeven point also lowers the cost of the trade. 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 were purchased, the loss would be limited to Rs. 170.45, which is the premium paid for the Call. However, it's important to note that this strategy also comes with limited gains and is, therefore, ideal when markets are moderately bullish.
