The strike price of the short call, represented by point B, is higher than the strike price of the long call, represented by point A, implying that the investor will always have to pay for the trade. The primary goal of the short call is to help pay for the initial cost of the lengthy conversation.
Profit/Loss
- A bull call spread’s maximum profit is computed by subtracting the difference between the two strike prices from the premium paid. This is achieved when the strike price at expiration exceeds the aforementioned strike price
- The maximum loss is the trade’s cost. At expiration, the stock must trade below the lower strike price.
Breakeven
A bull call spread’s breakeven point is the lower strike price plus the cost of the trade.
Breakeven = long call strike + net debit paid
Example
A Rs.2.50 call spread would consist of buying a 55-strike price call and selling a 65-strike price call, with a Rs.10 wide strike width (65 -55), which is the maximum profit the investor could make on the trade, minus the premium paid to enter the trade, in our example Rs.2.50, leaving the investor with a maximum profit of Rs.7.50.
If the vertical has both strikes in the money, time would be on the investor’s side since they would want this transaction to end as soon as possible so that there is no more time for it to go against them.
Conclusion
The recommendation, this is not a strategy that should be executed very often unless there is evidence of an expected upward movement. Without that it’s a lower probability of success trade that relies on a stock to trade higher.
It needs less capital to engage than merely acquiring shares, implying lower risk, but it is still seen as a trade with a lower possibility of success.
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