Bull Spread

A bull spread is an options trading strategy used by investors who anticipate a moderate rise in the price of an underlying asset. The strategy involves simultaneously buying and selling options of the same type (either both calls or both puts) with the same expiration date but different strike prices. It allows traders to profit from an upward price movement while limiting potential losses, making it a popular strategy among conservative investors in derivatives markets.

Concept and Nature

The term bull spread derives from the expectation of a “bullish” market, where prices are expected to rise. However, unlike outright speculation, this strategy aims to capitalise on a modest price increase rather than a large upward surge.
Bull spreads are constructed using either:

• Call options (Bull Call Spread), or
• Put options (Bull Put Spread).

Both strategies create a range of potential profit and loss outcomes, defined by the difference between the strike prices and the premiums paid or received.

Types of Bull Spread

1. Bull Call Spread

A bull call spread involves:

• Buying a call option with a lower strike price, and
• Selling another call option with a higher strike price, both with the same expiry.

This combination creates a limited-risk, limited-reward position.
Example: Suppose the share price of XYZ Ltd. is ₹100.

• The trader buys a call option with a strike price of ₹100 for a premium of ₹5.
• Simultaneously, they sell a call option with a strike price of ₹110 for a premium of ₹2.

Net Premium Paid = ₹5 – ₹2 = ₹3.

• If the share price rises to ₹110 or above, the trader earns a maximum profit equal to the difference in strike prices (₹10) minus the net premium (₹3) = ₹7.
• If the share price remains below ₹100, both options expire worthless, and the trader loses the net premium of ₹3.

Thus, profit potential is capped at ₹7, and loss is limited to ₹3.

2. Bull Put Spread

A bull put spread involves:

• Selling a put option with a higher strike price, and
• Buying another put option with a lower strike price, both with the same expiry date.

This strategy generates an initial net credit (income) because the premium received from selling the higher strike put is greater than the premium paid for the lower strike put.
Example: Using the same stock (XYZ Ltd.) at ₹100:

• Sell a put with a strike price of ₹100 for a premium of ₹5.
• Buy a put with a strike price of ₹90 for a premium of ₹2.

Net Premium Received = ₹5 – ₹2 = ₹3.

• If the stock stays above ₹100, both puts expire worthless, and the trader keeps the premium of ₹3 as profit.
• If the price falls below ₹90, the trader incurs the maximum loss equal to the difference in strike prices (₹10) minus the net premium (₹3) = ₹7.

Thus, the bull put spread also offers limited profit and limited risk, but it generates income upfront.

Comparison Between Bull Call and Bull Put Spreads

Both strategies are employed for the same market view — a moderate rise in the underlying price — but differ in structure and cash flow timing.

Payoff Structure

The payoff of a bull spread strategy forms a trapezoidal shape on a profit–loss diagram, illustrating capped profit and limited loss.

• When the underlying asset’s price remains below the lower strike (in a call spread) or below the lower limit (in a put spread), the trader incurs a small loss (the premium).
• As the price rises between the two strike prices, the position becomes profitable.
• Beyond the upper strike price, profit remains constant, as gains on one option are offset by losses on the other.

Strategic Objectives

The bull spread is used to:

• Profit from moderate upward movement in the price of an asset.
• Limit risk exposure, unlike naked option buying.
• Reduce cost of entry, since selling one option partially offsets the cost of buying another.
• Control volatility exposure, as the position’s net delta is positive but limited.

It is particularly suited to traders who are confident about a small or gradual rise in prices but do not expect dramatic market moves.

Factors Affecting Bull Spread Performance

• Underlying Price Movement: Profit or loss depends on whether the price moves within the expected range.
• Time Decay (Theta): Both long and short options lose value as expiration nears, with net impact depending on position structure.
• Implied Volatility: A decline in volatility tends to benefit bull call spreads and harm bull put spreads, as option premiums decrease.
• Interest Rates and Dividends: Affect option pricing but have a limited impact on short-term spreads.

Advantages of Bull Spread

• Limited Risk: The maximum loss is known at the outset.
• Controlled Cost: The sale of one option reduces the net premium paid.
• Flexibility: Can be implemented using calls or puts, depending on the trader’s preference.
• Simplicity: Easy to construct and manage.
• Useful in Low-Volatility Markets: Effective when price changes are moderate.

Limitations

• Capped Profit: Potential gains are restricted even if the price rises sharply.
• Requires Directional Accuracy: Losses occur if the underlying asset moves sideways or declines.
• Sensitive to Market Timing: Returns diminish if price movement occurs too slowly before expiry.

Practical Applications

• Hedging: Investors use bull spreads to protect existing short positions or to hedge against downside risk while maintaining upside potential.
• Income Generation: Bull put spreads allow traders to earn premiums in stable or mildly bullish markets.
• Cost Reduction: Traders use spreads instead of outright long calls to reduce capital outlay.

Example in Practice

Suppose an investor expects a stock currently trading at ₹200 to rise modestly in the near term. They could create a bull call spread by:

• Buying a ₹200 call for ₹10, and
• Selling a ₹220 call for ₹4.

Net Cost = ₹6.If the stock rises to ₹220 or above, the profit is capped at ₹14 (₹20 difference – ₹6 net cost). If the stock remains below ₹200, the loss is limited to ₹6.
This demonstrates the strategy’s balanced profile — conservative but effective under moderate bullish conditions.