Bull Call Spread (Trading Plan)

Bull Call Spread

Moving Average Crossover

Overview:  A Bull Call spread involves purchasing an ITM Call option and selling an ATM Call with the same expiration date but a higher strike price.  The sale of the higher strike Call brings in premium to offset the cost of buying the lower strike Call.  The maximum profit is achieved when the underlying stock rises above the higher strike price.  Look for spreads that offer at least a 50% rate of return.

Strategy	Outlook	Strike Price	Risk
Buy a Call (ITM)	Bullish	Lower Strike Price	Net Debit Paid
Sell a Call (ATM)	Bullish	Higher Strike Price	Net Debit Paid

Step #1:  Identifying Stocks.  Use “FINVIZ.com” which will help you find quality stocks where the shorter 9-EMA recently crossed above the longer 18-EMA.

Step #2:  Review Charts.  Determine trend on weekly chart first, then look for trades on the daily chart only in that direction.  When the weekly trend is up, it allows you to trade only from the long side.

Step #3:  Set Interval.  Typically, I trade spreads that are $5.00 wide.  For stocks over $100.00, I may increase that to $10.00.  For lower-priced stocks and some ETFs, I may reduce my spread width to $2.00.

S&P 500 (SPY) $133.92                                          Days to Expiration:  46

BTO (1) Aug 11 132 C @ $4.11  Delta:  0.62      Breakeven:  $134.81

STO (1) Aug 11 137 C @ $1.30  Delta:  0.33      Maximum  Profit:  $219.00

Net Debit Paid:  $2.81  ($281.00)                        Return % of Risk:  77.9%

Step #4:  Strike Price (Long Position).  A good strategy is to buy an ITM (strike price < stock price) Call with at least 45 days or less until expiration.  It’s the one we’re using to make money.

Step #5:  Strike Price (Short Position).  A good strategy is to sell an ATM (strike price = stock price) Call with at least 45 days or less until expiration.  We are lowering our cost basis and thus limiting risk.

Step #6:  Net Debit.  The amount you paid for the long Call (the debit) minus what you received from the short Call (the credit).  Keep the net debit as low as possible to make the trade worthwhile.

Step #7:   Breakeven.  Make sure the breakeven is within the trading range of the underlying stock (Lower Strike + Net Debit Paid).  The trade makes money if the stock is above breakeven by expiration.

   

Step #8:  Maximum Profit.  The maximum profit for the trade is the differences in strikes minus net debit paid.  (Differences in Strikes – Net Debit Paid)  Occurs when the stock closes above short Call.

Step #9:  Return % of Risk.  Look for spreads that offer at least 50% or greater maximum return. 

(Max Profit / Net Debit Paid)

Step #10:  Delta.  With a Bull Call spread, you are buying a Call with a larger Delta and selling a smaller Delta Call against it.  Both will increase in value as the stock goes up, but the long Call will increase faster—and this creates the spread that we need for a profit.

Step #11:  Exiting the Position.  Attempt to hold the position until expiration week.  Exit when the value of the trade has reached a (50%) rate of return.  Use a (50%) stop-loss for downside protection.

Exit the Trade

To exit a Bull Call spread, it is important to monitor the daily price movement of the underlying stock and the fluctuating option premiums.  Let’s explore what happens to the trade in the following scenarios:

If the underlying stock rises above the short strike ($137.00).  The short Call is assigned and you are obligated to deliver (100) shares of stock to the option holder at $137.00 a share.  By exercising the long Call, you can buy (100) shares of stock at $132.00 a share and pocket the difference of $500.00 (not including commissions).  By subtracting the cost of the trade ($281.00), the net profit on the spread is $219.00—the maximum profit available.

If the underlying stock rises above the breakeven ($134.81), but not as high as the short strike ($137.00).  Offset the options by selling a $132.00 Call at a profit and buying a $137.00 Call back at a slight loss, pocketing a small profit.

If the underlying stock remains below the breakeven ($134.81), but above the long strike ($132.00).  Sell a $132.00 Call at a profit and buy a $137.00 Call at a loss, pocketing a small profit; or wait until expiration and sell the long Call at a slight profit to offset the trade’s net debit and let the short option expire worthless.

If the underlying stock falls below the long strike ($132.00):  Let the options expire worthless, or sell a $132.00 Call prior to expiration to mitigate some of the loss.