A bull spread strategy is a strategy of financial options that seeks to limit both the increases in the underlying asset and the decreases, assuming small stable losses if the underlying falls in exchange for limited gains if the underlying rises.
A bull spread strategy can build both call options as put options . To explain it we will follow the example with calls. In this way we would build a bullish spread strategy with calls buying a call option and selling another call option with a higher strike price (PE) than the previous call to finance. Normally the call that is bought has a lower price than the current price of the underlying and the option that sells a higher price. Let’s see it graphically to understand it better:
In this way, if the share price remains stable, we will have earned the premium of the option sold and obtained the value of the option purchased if the EP is lower than the final price. If the price of the underlying rises we will win, as the PE of the call we have bought is greater than the call sold we will obtain a benefit, while if the underlying asset falls we will have small losses because we lose the price of the call purchased and the benefit of the call sold does not compensate.
The results of this operation will be:
Maximum loss = premium call 1 – premium call 2
Maximum gain = PE2 – PE1 – premium 1 + premium 2
Neutral = PE1 + premium2 – premium1
Example of a bullish spread strategy
Assume that the price of Telefónica at the moment is 12 euros. To make a bullish spread strategy an investor can buy a call option on Telefónica with a PE of 10 euros and a premium of 2 euros, and at the same time sell an option on Telefónica with PE 15 euros in exchange for a premium of 0.5 Euros
Maximum loss = premium call 1 – premium call 2 = 2 – 0.5 = € 1.5.
Maximum gain = PE2 – PE1 – premium 1 + premium 2 = 15 – 10 – 2 + 0.5 = € 3.5.
Deadlock = PE1 + premium2 – premium1 = 10 + 0.5 – 2 = € 11.5.