What Is Bull Spread? How It Works As Trading Strategy and Example

A bull spread is an options trading strategy that involves buying and selling options of the same type (either calls or puts) on the same underlying asset with the same expiration date but different strike prices. The goal is to profit from a moderate increase in the price of the underlying asset. Bull spreads are considered vertical spreads because they involve options with different strike prices within the same expiration period.

There are two primary types of bull spreads:

Bull Call Spread: This involves buying a call option with a lower strike price and selling a call option with a higher strike price. It is a debit spread, meaning the trader pays a net premium to enter the position.
Bull Put Spread: This involves selling a put option with a higher strike price and buying a put option with a lower strike price. It is a credit spread, meaning the trader receives a net premium upfront.

Both strategies are designed to benefit from a rising asset price, but they differ in cash flow and risk dynamics, which we’ll explore later.

Why Use a Bull Spread?

Bull spreads are popular because they offer a balanced approach to trading. Unlike simply buying a call option, which exposes the trader to unlimited loss of the premium if the trade goes wrong, a bull spread caps both losses and gains. This makes it an attractive strategy for traders who want to:

Limit downside risk.
Reduce the cost of entering a bullish position compared to buying a single call option.
Take advantage of moderate price increases without needing a massive rally.
Maintain a defined risk-reward ratio.

Bull spreads are commonly used in markets where the trader expects steady, incremental price growth rather than explosive upward moves. They are also effective in volatile markets, as the sale of an option helps offset the cost of the purchased option.

How a Bull Spread Works

To understand how a bull spread works, let’s break down the mechanics of each type: the bull call spread and the bull put spread.

Bull Call Spread

A bull call spread involves the following steps:

Buy a Call Option: The trader purchases a call option with a lower strike price (e.g., $50). This option gives the trader the right to buy the underlying asset at the strike price before or at expiration.
Sell a Call Option: Simultaneously, the trader sells a call option with a higher strike price (e.g., $55) on the same underlying asset with the same expiration date. This option obligates the trader to sell the underlying asset at the higher strike price if exercised.

The difference between the premiums paid and received is the net cost of the trade, also known as the net debit. The trader’s maximum loss is limited to this net debit, while the maximum profit is capped at the difference between the strike prices minus the net debit.

Payoff Structure of a Bull Call Spread

Maximum Profit: Calculated as [(Higher Strike Price – Lower Strike Price) – Net Debit] × 100 (assuming one contract represents 100 shares).
Maximum Loss: Limited to the net debit paid (Premium Paid – Premium Received) × 100.
Breakeven Point: Lower Strike Price + Net Debit.

The bull call spread profits if the underlying asset’s price rises above the breakeven point but below or up to the higher strike price at expiration.

Bull Put Spread

A bull put spread involves the following steps:

Sell a Put Option: The trader sells a put option with a higher strike price (e.g., $50). This option obligates the trader to buy the underlying asset at the strike price if the option is exercised.
Buy a Put Option: Simultaneously, the trader buys a put option with a lower strike price (e.g., $45) on the same underlying asset with the same expiration date. This option gives the trader the right to sell the underlying asset at the lower strike price.

Since the premium received from selling the put is typically higher than the premium paid for buying the put, the trader receives a net credit upfront. The maximum profit is this net credit, while the maximum loss is limited to the difference between the strike prices minus the net credit.

Payoff Structure of a Bull Put Spread

Maximum Profit: Limited to the net credit received (Premium Received – Premium Paid) × 100.
Maximum Loss: Calculated as [(Higher Strike Price – Lower Strike Price) – Net Credit] × 100.
Breakeven Point: Higher Strike Price – Net Credit.

The bull put spread profits if the underlying asset’s price stays above the higher strike price at expiration, allowing both options to expire worthless and the trader to keep the net credit.

Key Differences Between Bull Call and Bull Put Spreads

While both strategies are bullish, they differ in execution and suitability:

Cash Flow: A bull call spread requires an upfront payment (debit), while a bull put spread generates an upfront credit.
Risk Profile: Both limit risk, but the bull put spread may appeal to traders who prefer collecting premiums upfront.
Market Conditions: Bull call spreads are often used when the trader expects a moderate price increase, while bull put spreads can be effective in neutral-to-bullish markets where the asset price is expected to stay above a certain level.

Bull Spread as a Trading Strategy

The bull spread is a strategic tool for traders who want to balance optimism with caution. Here’s how it fits into a broader trading strategy:

When to Use a Bull Spread

Moderate Bullish Outlook: If a trader believes a stock, index, or ETF will rise modestly (e.g., due to an upcoming earnings report, positive economic data, or sector trends), a bull spread allows them to profit without betting on a large move.
High Volatility Environments: In volatile markets, options premiums can be expensive. Selling an option as part of a spread reduces the overall cost compared to buying a single call option.
Capital Efficiency: For traders with limited capital, bull spreads are more affordable than outright stock purchases or single-option strategies.
Hedging: Bull spreads can be used to hedge other positions or as part of a larger portfolio strategy to diversify risk.

Advantages of Bull Spreads

Defined Risk: The maximum loss is capped, making it easier to manage risk compared to uncovered options strategies.
Lower Cost: By selling an option, the trader offsets the cost of the purchased option, reducing the capital required.
Flexibility: Traders can adjust strike prices and expiration dates to match their outlook and risk tolerance.
Profit in Moderate Moves: Unlike strategies requiring significant price swings, bull spreads thrive in steady, incremental gains.

Risks of Bull Spreads

Capped Profits: The maximum gain is limited, so a trader misses out on additional profits if the asset price surges beyond the higher strike price.
Time Decay: For bull call spreads, time decay (theta) can erode the value of the purchased option, especially if the asset price doesn’t move as expected.
Assignment Risk: In bull put spreads, there’s a risk of early assignment if the sold put goes in-the-money, particularly before expiration.
Market Risk: If the underlying asset’s price falls instead of rising, the trader could lose the net debit (bull call spread) or face losses up to the maximum loss (bull put spread).

Strategic Considerations

To maximize the effectiveness of a bull spread, traders should:

Choose Appropriate Strike Prices: Wider spreads (larger difference between strike prices) offer higher potential profits but also increase risk. Narrow spreads reduce risk but cap profits.
Monitor Implied Volatility: High implied volatility can inflate premiums, affecting the cost of a bull call spread or the credit received in a bull put spread.
Time the Trade: Since options have expiration dates, traders must align the trade’s duration with their price movement expectations.
Exit Strategy: Have a plan to close the position before expiration, either to lock in profits or cut losses, especially if the market moves unexpectedly.

Example of a Bull Call Spread

Let’s walk through a practical example to illustrate how a bull call spread works.

Scenario

Suppose a trader is bullish on XYZ Corp, currently trading at $50 per share. The trader expects the stock to rise to around $55 over the next month due to a positive product launch. To capitalize on this, the trader decides to implement a bull call spread.

Trade Setup

Buy 1 Call Option: Strike price of $50, expiring in one month, with a premium of $3 per share ($300 total, since 1 contract = 100 shares).
Sell 1 Call Option: Strike price of $55, expiring in one month, with a premium of $1 per share ($100 total).
Net Debit: $300 – $100 = $200.

Payoff Analysis

Maximum Profit: ($55 – $50 – $2) × 100 = $300.
Maximum Loss: $200 (the net debit).
Breakeven Point: $50 + $2 = $52.

Possible Outcomes at Expiration

Stock Price at $60: The $50 call is in-the-money by $10 ($60 – $50), worth $1,000. The $55 call is in-the-money by $5 ($60 – $55), costing $500 to cover. Net profit = $1,000 – $500 – $200 (initial debit) = $300.
Stock Price at $53: The $50 call is in-the-money by $3, worth $300. The $55 call expires worthless. Net profit = $300 – $200 = $100.
Stock Price at $50 or Below: Both calls expire worthless. The trader loses the net debit of $200.

Interpretation

In this example, the trader benefits if XYZ Corp’s stock price rises above $52 but doesn’t need it to soar beyond $55 to achieve the maximum profit. The capped loss of $200 makes the trade manageable, even if the stock declines.

Example of a Bull Put Spread

Now, let’s consider a bull put spread for the same stock, XYZ Corp, at $50.

Trade Setup

Sell 1 Put Option: Strike price of $50, expiring in one month, with a premium of $2 per share ($200 total).
Buy 1 Put Option: Strike price of $45, expiring in one month, with a premium of $0.50 per share ($50 total).
Net Credit: $200 – $50 = $150.

Payoff Analysis

Maximum Profit: $150 (the net credit).
Maximum Loss: ($50 – $45 – $1.50) × 100 = $350.
Breakeven Point: $50 – $1.50 = $48.50.

Possible Outcomes at Expiration

Stock Price at $50 or Above: Both puts expire worthless. The trader keeps the $150 net credit as profit.
Stock Price at $47: The $50 put is in-the-money by $3, costing $300 to cover. The $45 put expires worthless. Net loss = $300 – $150 = $150.
Stock Price at $45 or Below: The $50 put is in-the-money by $5, costing $500. The $45 put is worthless. Net loss = $500 – $150 = $350.

Interpretation

The bull put spread is profitable as long as XYZ Corp stays above $48.50. The trader collects the premium upfront, which is appealing for those who prefer immediate cash flow, but the maximum loss is higher than in the bull call spread example.

Conclusion

The bull spread is a powerful options strategy for traders with a moderately bullish outlook. By combining the purchase and sale of options, it offers a controlled way to profit from rising asset prices while capping both risk and reward. The bull call spread suits traders willing to pay upfront for a chance at higher profits, while the bull put spread appeals to those who prefer collecting premiums and betting on price stability or modest gains. Both strategies require careful planning, including selecting appropriate strike prices, monitoring market conditions, and having a clear exit strategy.