Call Spreads Explained

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Contents

Call Spreads

A call spread is an option spread strategy that is created when equal number of call options are bought and sold simultaneously. Unlike the call buying strategy which have unlimited profit potential, the maximum profit generated by call spreads are limited but they are also, however, comparatively cheaper to implement. Additionally, unlike the outright purchase of call options which can only be employed by bullish investors, call spreads can be constructed to profit from a bull, bear or neutral market.

Vertical Call Spread

One of the most basic spread strategies to implement in options trading is the vertical spread. A vertical call spread is created when the short calls and the long calls have the same expiration date but different strike prices. Vertical call spreads can be bullish or bearish.

Bull Vertical Call Spread

The vertical bull call spread, or simply bull call spread, is used when the option trader thinks that the underlying security’s price will rise before the call options expire.

Bear Vertical Call Spread

The vertical bear call spread, or simply bear call spread, is employed by the option trader who believes that the price of the underlying security will fall before the call options expire.

Calendar (Horizontal) Call Spread

A calendar call spread is created when long term call options are bought and near term call options with the same strike price are sold. Depending on the near term outlook, either the neutral calendar call spread or the bull calendar call spread can be employed.

Neutral Calendar Call Spread

When the option trader’s near term outlook on the underlying is neutral, a neutral calendar call spread can be implemented using at-the-money call options to construct the spread. The main objective of the neutral calendar call spread strategy is to profit from the rapid time decay of the near term options.

Bull Calendar Call Spread

Investors employing the bull calendar call spread are bullish on the underlying on the long term and are selling the near term calls with the intention of riding the long term calls for a discount and sometimes even for free. Out-of-the-money call options are used to construct the bull calendar call spread.

Diagonal Call Spread

A diagonal call spread is created when long term call options are bought and near term call options with a higher strike price are sold. The diagonal call spread is actually very similar to the bull calendar call spread. The main difference is that the near term outlook of the diagonal call spread is slightly more bullish.

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

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  • BINOMO
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    Trustful broker.

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Long Call Spread Strategy Explained (A Simple Guide)

If you have an upside price target on a stock for the near future and you’re an options veteran, consider opening a long call spread.

A long call spread, or bull call spread, helps you generate some quick, high-percentage profits. It also limits your risk.

At the same time, though, you’ll limit your gain. But that’s why it’s a perfect strategy if you have a short-term price target in mind for the stock.

Even with the limited gain, though, you can rack up profits that amount to well over 100%.

That’s hardly a bad day of trading.

In this tutorial, I’ll explain the long call spread so you can determine if it’s right for your investment objectives.

What Is A Long Call Spread?

A long call spread is what advanced options traders call a vertical spread.

If you’re unfamiliar with the concept of a vertical spread, it’s an options strategy that involves both the purchase and sale of the same kind of option at the same expiration date but at different strike prices.

In the case of a long call spread, you’d buy a call option at one strike price for a specific expiration date. At the same time, you’d sell (or “write”) a call option for a higher strike price on the same date.

The benefit of the strategy is that you’ve also got some insurance. If the price of the underlying stock plummets, you won’t lose your shirt. Your risk is limited because you’ve got a short position.

However, that short position also limits your gain.

When Would You Use A Long Call Spread?

A great time to use a long call spread is when you think a stock has the potential to go up in the short term and you have a specific price target in mind.

The reason that it’s important to have a price target in mind is because, as I mentioned above, your profit is limited. That limit is dictated by the price target.

In other words, even if the stock soars above the price target, you won’t make any additional profits.

How Does A Long Call Spread Work?

Before you enter into a long call spread, it’s important to ensure that your trading platform supports multi-leg options orders.

A multi-leg options order allows you to buy or sell several different options with a single order.

Options traders should have access to multi-leg orders as a matter of practice. In the case of a long call spread, though, it’s essential.

Why? Because when you enter into a long call spread you’re shorting a call. That means your loss could be infinite if you don’t have the corresponding long call to go alongside it.

Shorting a call is sometimes called writing a naked call.

When you write a naked call, you’re selling the right for somebody to buy shares of stock that you don’t own. That can result in disastrous consequences if the price of the stock skyrockets.

Now that I’ve explained the basics of multi-leg orders and naked calls, let me explain how a long call spread works.

In one leg, you buy a call option at an in-the-money strike price for a particular stock. In the other leg, you sell a call option at a higher, out-of-the-money strike price. It’s important that both options expire on the same date.

If the stock price goes up before the expiration date, you’ll make money because the long option will increase in value. However, your profit will be limited because you’ve shorted a call at a higher strike price.

What that basically means is that you won’t see any additional profit if the stock price rises above the higher strike price.

That higher strike price, by the way, is your target price. That’s where you think the stock is headed in the short term.

Real Life Example Using A Long Call Spread?

Let’s say that Cheesecake Factory is currently trading at $52 per share. You think it has the potential to hit $55 per share within the next month, so you enter a long call spread.

In your multi-leg order, you simultaneously buy a $50 call at $3.20 and sell a $55 call at $1.00.

Remember, though, an options contract consists of 100 shares and the price is a per-share price. So you pay $320 ($3.20 x 100) for the long call while pocketing $100 ($1.00 x 100) for the short call.

Suppose that in the next month the price of Cheesecake Factory stock rises to $54 per share. That means, at expiration, the value of your long option position is $400 ($4.00 x 100). Your short option expires worthless because it’s below the strike price, so you get to keep the money you earned from the sale of the naked call.

Your initial investment of $320 turns into a position worth $400 on the long side. But you also get to keep the money you earned from the naked call. That’s another $100 in profit, bringing the total value of the spread to $500.

So in one month you earned a 56% return.

Now, let’s say that the stock price of Cheesecake Factory soars to $58 per share. That’s great news because you’ll make a whole lot more money, right?

Unfortunately, no. You won’t make that much more money because of the short call.

In that case, the long call position appreciates in value from $320 to $800 ($8 x 100). The call on the short side appreciates in value to $300, but that means you’ll take a loss because it’s a short position.

You have to buy to close the short position for $300 ($3 x 100). Since you earned $100 when you sold it originally, you’re looking at a loss of $200.

The total value of your spread is now $600, or a return of 87.5%. That’s still a good day at the office.

If Cheesecake Factory shares drop below $50 at expiration, then both options expire worthless. You keep the $100 from the sale of the call but lose the $320 you invested in the long call. Your total loss in that case is $220.

What Are Similar Strategies In Relation To Long Call Spread?

Here are a few strategies similar to a long call spread:

  • Collar Option – A strategy that involves writing covered calls against shares of stock you own while simultaneously buying protective puts.
  • Bull Put Spread – A strategy that involves buying one put option while writing another put option at a higher strike price. As the name implies, it’s used when you’re bullish on a stock price.

Long Call Spread Compared To Other Options Strategies?

As you can probably tell from reading this guide, the long call spread is a strategy designed for advanced options traders. If you’re new to trading options, you should get more experience before you practice it.

You also need to make sure that your trading platform supports multi-leg options trades before you open a long call spread. You won’t need to do that if you’re using simpler options strategies, like the long call.

Also, some options strategies, such as protective puts, offer unlimited gain with limited risk. The long call spread, though, also offers limited gain.

Call Spreads

A call spread is an option spread strategy that is created when equal number of call options are bought and sold simultaneously. Unlike the call buying strategy which have unlimited profit potential, the maximum profit generated by call spreads are limited but they are also, however, comparatively cheaper to implement. Additionally, unlike the outright purchase of call options which can only be employed by bullish investors, call spreads can be constructed to profit from a bull, bear or neutral market.

Vertical Call Spread

One of the most basic spread strategies to implement in options trading is the vertical spread. A vertical call spread is created when the short calls and the long calls have the same expiration date but different strike prices. Vertical call spreads can be bullish or bearish.

Bull Vertical Call Spread

The vertical bull call spread, or simply bull call spread, is used when the option trader thinks that the underlying security’s price will rise before the call options expire.

Bear Vertical Call Spread

The vertical bear call spread, or simply bear call spread, is employed by the option trader who believes that the price of the underlying security will fall before the call options expire.

Calendar (Horizontal) Call Spread

A calendar call spread is created when long term call options are bought and near term call options with the same strike price are sold. Depending on the near term outlook, either the neutral calendar call spread or the bull calendar call spread can be employed.

Neutral Calendar Call Spread

When the option trader’s near term outlook on the underlying is neutral, a neutral calendar call spread can be implemented using at-the-money call options to construct the spread. The main objective of the neutral calendar call spread strategy is to profit from the rapid time decay of the near term options.

Bull Calendar Call Spread

Investors employing the bull calendar call spread are bullish on the underlying on the long term and are selling the near term calls with the intention of riding the long term calls for a discount and sometimes even for free. Out-of-the-money call options are used to construct the bull calendar call spread.

Diagonal Call Spread

A diagonal call spread is created when long term call options are bought and near term call options with a higher strike price are sold. The diagonal call spread is actually very similar to the bull calendar call spread. The main difference is that the near term outlook of the diagonal call spread is slightly more bullish.

You May Also Like

Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

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    BINARIUM

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    Perfect for Beginners!
    Free Trading Education! Free Demo Acc!
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  • BINOMO
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    Trustful broker.

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