Beginner’s Bull Spread Trading Guide
Beginners might find financial market trading fascinating and intimidating. Traders use several methods to benefit from market changes. Traders employ the bull spread to profit from bullish markets. This post will discuss bull spreads and how to use them in trading.
Bull Spread and what is it?
Bull spread trading includes buying and selling two options contracts. It is usually employed by traders who predict an asset’s price to grow significantly over time. Bull spreads comprise two options contracts: long and short call.
The long call option offers the holder the right, but not the duty, to purchase the underlying asset at the strike price on or before the expiry date. The bull spread trader buys the long call option to profit from the price rise.
Short call options, on the other hand, require the trader to sell the asset at the strike price if the holder exercises it. Selling the short call option in a bull spread generates money and reduces the cost of the long call option.
Bull Spread Strategy Implementation
An example will explain bull spread technique execution. Say you think Company XYZ’s $50 stock will climb somewhat next month. You choose a bull spread strategy employing $55 options contracts.
Create the bull spread:
Buy a long $55 call option at $2 per contract.
Short call option with $55 strike price, $1 premium per contract.
The long call option lets you purchase Company XYZ’s shares at $55, regardless of market price. If the stock price rises, you may benefit from this option.
Selling the short call option requires you to sell the shares at $55 if executed. You earned a $1 premium per contract for selling this call option, lowering the net cost of the long call option.
Thus, a bull spread strategy’s maximum loss is the net cost of purchasing the long call option less the premium obtained for selling the short call option. However, because stock prices might grow dramatically, the maximum profit is potentially infinite.
Risks and Reward
Understanding the dangers of a bull spread might help you benefit from a bullish market. First, if the stock price does not increase as projected or stays below the strike price of $55, both long and short call options may expire worthless, losing the premiums.
Profit potential is restricted if the stock price climbs considerably over the strike price. When executed, the short call option requires selling the stock at the strike price, losing potential profits. Adjusting the strike price or expiry dates of options contracts helps mitigate this risk.
Sources and References
This article is intended to provide beginners with a basic understanding of the bull spread trading strategy. For in-depth information and further reading, you may refer to the following sources and references:
- Options Industry Council – Bull Call Spread
- Investopedia – Bull Spread
- Options Playbook – Bull Call Spread
Remember, before implementing any trading strategy, it is crucial to conduct thorough research, consider your risk tolerance, and seek advice from a qualified financial professional.