Bull Call Spread- Study Notes -P1.T3. Financial Markets & Products

[gargi.adhikari]

Hi,
I was trying to get a hang of the Bull Call Spread Strategy and in the study Notes -P1.T3. Financial Markets & Products, came across the footnote of the Payoff Diagram of this strategy as :-
Payoff: Red; put option: Green; call option: Blue. If I understood this right, isn't the Green Payoff represent a Short Call with the Higher Strike Price since this is a Bull Call Spread? Just trying to make sure I am not missing anything and interpreting this right...Thanks much again for sharing insights on this..

 

[jairamjana]

I don't have the BT Notes but I will take a guess of how the strategy is likely presented.. Payoff for Bull Call and Bull Put spread are same.. Refer here

(ie, http://www.theoptionsguide.com/images/bull-call-spread.gif)

(ie, http://www.theoptionsguide.com/images/bull-call-spread.gif)

As you can see the zig zag pattern is same be it call or put bull.. As price increases it will tilt in favour of positive payoff hence its a expectation of a bullish stock.. We need to long a call and short a call simultaneously and .. We short the call which has a higher strike price compared to long call (essentially the short call should be OTM) ... This will be a Bull Call Spread..

Now this will be a guess but I think.. Blue represent the payoff of a plain vanilla Long Call .. (is it sloping upwards as price increases)..? and put which is represented in green must be sloping downwards? (plain vanilla long put).. If that's how the lines looks then I am right.. They are just individual long call/put options strategies put in same graph if that's the case..
And also the red payoff is the payoff the strategy Bull Call/Put ...

For more on Options Strategies.. Please do check out here
https://forum.bionicturtle.com/threads/options-strategy-resource.9251/

This might be helpful..

 

[David Harper CFA FRM]

Hi @gargi.adhikari yes, you are correct: I am sorry for the typo in the exhibit (is also mistakenly includes "Protective put"). Otherwise, the text looks correct: "A bull spread can be created by writing a call with, e.g. strike fx = $23 , while going long a call with a lower strike price, f| ! = $20, on the same stock (with the same expiration). In this example, we go long a call @ strike = $20, with a premium = $1.99 + short call @ strike = $23, with a premium = $0.83"

 

[gargi.adhikari]

Got it...perfecto....thanks so much.

 

[QuantMan2318]

The entire thing here is my line of reasoning, someone with a practical exposure in the options trading can correct me if I am wrong (@David Harper CFA FRM or @ShaktiRathore?).
I personally feel that though we may use the Put to have a Bull spread strategy, the pay off structure is slightly different for a Bull Put vis a vis a Bull Call. If I understand it correctly, the Bull Put is used as a means of leveraged trading, there is no initial investment required in a Bull Put as the Short Put of a Higher Strike price commands a higher premium than the Long Put of a lower Strike price, this is in direct contravention of the Bull Call as the Higher Strike prices usually have a lower premium and requires initial investment.

My point is, if there is a Bull market, the the Trader benefits from the difference in premiums that poses the cap on the profits earned. The intention of the Trader here is very clear, he/she is expecting the underlying to rise and is limiting the loss, if it falls to K1-K2 and this loss is more for a Bull put than the equivalent loss for a Bull Call, this is in direct contravention to a Bull Call where the Trader expects the underlying to fall and puts a cap on the profits earned if and when they increase to K2-K1 and if the underlying falls, there is still some scope for profits in a Bull Call than a Bull Put and the final Loss amount here is restricted to the difference in premiums if there is a Bear Market.

In other words, if you are George Soros or John Paulson, you are certain that the market will rise while others expect it to fall, you enter into the Bull Put; If you are Warren Buffett, you are a little bit conservative and you want to provide both ways, you enter into the Bull Call

Here is the payoff and profit from both for comparison:
Bull Put
S>K2 payoff is 0 while premium from the short put is the profit while the premium from long put is the loss, the net profit is the difference in premium

S>K1 and S<K2
0 -(K2-S) is the payoff while the profit will be 0 -(K2-S)+premium on Short-premium on Long

S<K1 and S<K2
K1-S -(K2-S)
K1-K2 is the payoff, include the premium for the final amount of Loss

Bull Call

S>K2
K2-K1 is the payoff while the profit is the difference between Strike prices and the premium which reduces the profits

S>K1 and S<K2
S-K1 0

S<K1 and S<K2
0 0, the loss is the difference in premiums.