Definition: A bull spread is a vertical options strategy that seeks to attain maximum profit by capitalizing on a rise in the price of the underlying asset. The bull spread is constructed both with call and put options.
What Does Bull Spread Mean?
What is the definition of bull spread? A bull call spread involves two call option strike prices, a lower strike price that is usually exercised in-the-money (strike price < market price), and a higher strike price that is exercised out-of-the-money (strike price > market price). Both call components have the same maturity.
A bull put spread involves two put option strike prices, a higher strike price that is usually exercised in-the-money (strike price > market price), and a lower strike price that is usually exercised out-of-the-money (strike price < market price). Both put components have the same maturity.
Let’s look at an example.
Example
Bill holds 850 shares of a biomedical company that currently trade at $187.22. Following some good news about a new drug that got approved by the FDA, Bill believes that the stock price will rise over the next two months to $194. Therefore, he decides to buy a bull call spread.
Bill buys 40 long calls at $1.25, paying $125 and sells 40 short calls at $2.85, receiving $285. The total cost for this contract is $285- $125 = $160 plus commissions. Bill expects that the market price of the underlying security will rise before maturity.
Bill will realize a maximum gain if the market price rises above the strike price at maturity. Bill will exercise the long call component of the bull spread buying the lower strike call (long call) and simultaneously selling the higher strike call (short call). His gain is the difference between the higher strike call and the lower strike call minus the initial cost of the contract.
Bill will incur a maximum loss if the market price drops lower than the strike price at maturity. In this case, both call components of the bull spread will be out-of-the- money and the maximum loss will be limited to the initial cost of the contract.
Summary Definition
Define Bull Spread: A bull spread is an investing strategy where an investor purchase a call or put at a low strike price and sells another option at a high strike price to realize a profit as the underlying security increases in value.
