Options can be an exciting form of trading, and there can be opportunities to make big profits while also reducing risks. However, with so many options strategies to choose from, it can be challenging for a beginner to decide which approach will work best.
As you determine your own personal investment strategy — and gain clearance to trade options at higher levels — you can incorporate some more advanced options trading strategies if they align with your goals and risk tolerance.
One such strategy for bullish traders is the long call spread, which is available for options traders who have acquired a level 3 clearance. This two-legged strategy is for speculators who anticipate a modest price increase, and by combining a long call with a short one, they can reduce the cost of entry on the play (though also limiting their upside potential).
Let’s take a closer look.
Long Call Spread
A long call spread is a more conservative approach to betting bullishly on a stock and allows an investor to simultaneously purchase calls at a predetermined strike price while selling an equal number of calls at a higher strike price. Each of the call options includes the same stock and expiration date.
With this strategy, you have the right to buy the stock at the bought strike price, and the obligation to sell the underlying stock at the sold strike price if you are assigned. This strategy is best suited if you’re bullish on a stock and have an upside target in mind.
Take a look at this strategy using the RBLL stock from a previous section. Let’s say you think RBLL is going to run higher in the near term but are nervous about potential technical resistance near $55. You could buy to open the 50-strike call for $3, while simultaneously selling to open the 55-strike call for $1.50, resulting in a net debit of $1.50, or $150, on the trade.
By combining the long call with the short call, you’ve not only lowered your initial cost of entry, but also your breakeven mark to $51.50 (bought strike plus net debit) — compared to a breakeven price of $53 for those who just bought the 50-strike call outright.
However, you’ve also capped your reward at $3.50 per pair of contracts, or the difference between the two strikes less the net debit, no matter how far RBLL climbs past the sold call by options expiration.
It’s important to note that when you buy a call spread, you need to have some width between the call you are long and the call you are short.
Why?
If the spread is too tight, it would have to get deep in the money, or you have to wait to close out the trade as expiration approaches. You see strikes that are near each other will move closely together. If the stock moves higher, you’ll make money on your long call, but those gains will be small because of the short call.
On the other hand, you don’t want to sell call options that are too cheap. The purpose of a call spread is to bring your cost of entry down and reduce the role that time and volatility have on the trade. If the options you are looking to sell are relatively cheap, then it may be better to just buy the call outright.
Wrapping Up
The bull call spread is a good idea for traders when option volatility is high, and they want to make a bullish play on a stock. The downside is that your profit potential is capped; although it does reduce the amount you pay to play and gives you the chance for greater leverage.
