  For eg:

A bull spread is a widely used two leg option trading strategy that involves buying and selling the option contracts of equal quantity of any financial asset having the same expiration but different strikes such that the strategy delivers positive P&L when the underlying has a bullish movement, hence its name.

There are primarily two types which depend on if Calls are used, or Puts are used to implement the strategy

This strategy is deployed by buying ATM (at the money) call options while selling an equal number of OTM () call options of the same underlying and same expiry. While deploying this strategy, a net debit of the Premium will occur, or a cost will be involved in setting up this strategy.

• Max Loss = Net Premium Debit.
• Max Profit = (X2-X1) – Net Premium Debit.

This strategy is deployed by selling ATM (at the money) put options while buying an equal number of OTM (out of the money) put options of the same underlying and same expiry. While deploying this strategy, a net credit of the Premium will occur, or payment will be received on setting up this strategy.

Bull Put Spread Formula (Where: X1<X2, denote the strike price)

(Where X1< X2, denoting the strikes)

• Max Loss = (X2-X1) – Net Premium Credit.
• Max Profit = Net Premium Credit.

Let us take a listed company ABC whose stock is trading at \$100 currently.

• Following are the Strike Prices and LTP (last trading price) of the ATM and OTM Call options
• Strike Price = \$100 | LTP = \$5 (ATM)
• Strike Price = \$110 | LTP = \$4 (OTM)
• Following are the Strike Prices and LTP (last trading price) of the ATM and OTM
• Strike Price = \$100 | LTP = \$4 (ATM)
• Strike Price = \$90 | LTP = \$3 (OTM)

Solution:

From the given information we can create a ” description=”A bull call spread refers to a trading strategy where the trader speculates a limited price appraisal of the stock. Here, the trader bets on the same stock via two call options for the upper and lower strike price range.” url=”https://www.wallstreetmojo.com/bull-call-spread/”]Bull Call Spread[/wsm-tooltip] as following:

#1 – Net Premium (Debit) = Buy Call of Strike \$100 & Sell Call of Strike \$110

• Net Premium (Debit) = -\$5 +\$4 (Positive sign denoted inflow and Negative indicates outflow)
• Net Premium (Debit) = -\$1 (As this is negative quantity this is net outflow or debit)

• Max Loss = \$1

• Max Profit = (\$110-\$100) – \$1 = \$9

#1 – Net Premium (Credit) = Sell Put of Strike \$100 & Buy Put of Strike \$90

• Net Premium (Credit)  = +\$4 -\$3 (Positive sign denoted inflow and Negative indicates outflow)
• Net Premium (Credit)  = +\$1 (As this is positive quantity this is net inflow or credit)

#2 – Max Loss = (X2-X1) – Net Premium Credit

• Max Loss = (\$100-\$90) – \$1 = \$9

#3 – Max Profit = Net Premium Credit

• Profit = \$1

Practical Application Based Example

Let us take an example of Amazon.com Inc. stock and try to build a Call Spread & Put Spread strategy and also analyze the Profit and Loss from the payoff chart

#1 – Bull Call Spread on Amazon.com Inc.

At the end trading session on 25th October 2019, the following was the stock price of Amazon.com.

The option chain of Apple for options contracts expiring on 1st November is shown below.

The necessary data is now available for building this strategy.

We would deploy a Bull Call Spread on Amazon.com Inc. stock just a few minutes before the close of the market on 25th October 2019

The two strikes chosen are \$1760 and \$1763. The Calls of each of these strikes have been highlighted. In this case, a \$1760 strike Call (ATM) will be bought, and the same quantity of \$1763 strike Call (OTM) will be sold.

The prices highlighted on the will be used to build the payoff chart of the strategy.

When the premiums of each of these strikes were fed in the option strategy builder, the following result was obtained. It can be seen that the strategy has a of \$0.95.

Source: optioncreator.com

Source: optioncreator.com

The following points are the highlights of Amazon.com Inc. stock when held till expiry:

• Bull Call spread Max Loss is equal to the Net Premium paid at the time of deployment = \$0.95
• Bull Call Max profit = (1763-1760) – \$0.95 = \$3-\$0.95 = \$2.05
• The profit increases linearly as the stock price moves from \$1760 to \$1763, which are the two strikes chosen for this strategy.
• Breakeven point = \$1760 (Lower Strike) + \$0.95 (Net Premium Paid) = \$1760.95
• Below \$1760 & above \$1763 both the loss and gain are capped to \$0.95 & \$2.05 respectively.
• The risk-reward ratio is 2.05/0.95 = 2.16

#2 -Bull Put Spread on Amazon.com Inc.

We would now deploy a Bull Put Spread on Amazon.com Inc. stock just a few minutes before the close of the market on 25th October 2019

The two strikes chosen are \$1758 and \$1763. The Puts of each of these strikes have been highlighted. In this case, a \$1763 strike Put (ATM) will be sold, and the same quantity of \$1758 strike Call (OTM) will be bought.

The prices highlighted on the option chain will use to build the payoff chart of the strategy.

When the premiums of each of these strikes were fed in the option strategy builder, the following result was obtained. It can be seen that the strategy has a net credit of \$3.76.

Source: optioncreator.com

The following points are the highlights of Amazon.com Inc. stock when held till expiry:

• Bull Call spread Max gain is equal to the Net Premium paid at the time of deployment = \$3.76.
• Bull Call Max loss = \$3.76 – (1763-1758) = \$3.76-\$5= -\$1.24.
• The profit increases linearly as the stock price moves from \$1758 to \$1763, which are the two strikes chosen for this strategy.
• Breakeven point = \$1763 (Higher Strike) – \$3.76 (Net Premium Paid) = \$1759.24
• Below \$1758 & above \$1763 both the loss and gain are capped to \$1.24 & \$3.76 respectively.
• The risk-reward ratio is 3.76/1.24 = 3.03