Call bull spread consists of two out of the money call option positions (one sell and one buy) at the same time. Here the trader buys one call option with a low exercise price XL and sells another call option with a higher exercise price XH. For the first option he pays the premium of CL and for the second options he receives premium of CH.
As both the call options are out of the money and XL < XH, here CL will be higher than CH or CL > CH.
Suppose for this case,
XL = USD 100; XH = USD 150
CL = USD 20; CH = USD 10
Current Share Price, S0 = USD 80
Maximum Profit happens when the share price crosses the higher strike price range (XH = 150 USD) as beyond that the profit of the buy call option is negated by the loss of the sell call option. Maximum Profit = (XH-XL) – (CL-CH) = 50-10 = USD 40
Maximum Loss happens when the stock price goes below the lower strike price range (XL) as here both the options expire. After that losses stay same for any share price movement lower than XL. Maximum Loss = CL – CH = USD 10
Breakeven price is the share price where the profit stood at 0 and it separates profit from loss. Here the breakeven price would be = 100+20-10 = USD 110. The breakeven price can easily be determined from the table and the chart.
The following table shows the profit/loss scenarios for different share prices.
The below chart shows the profit/loss for the trading strategy option with the movement of the share price.
Here we have three graphs
We can check from the above graph that a call bull spread can only be worth as much as the difference between the two strike prices. So, the wider the strikes the more you profit. The cost of the bought call option will be partially offset by the premium received by the sold call option. This does, however, limit the potential gain if the stock price rises.
Trader or investor uses this strategy when he is sure than the stock price will go higher than the strike price of the buy call option and stay lower than the strike price of the sell call option. Through this trading strategy he intends to limit his maximum profit and loss.