TOOLS OF THE TRADE

THE BULL CALL 

The bull call is a vertical debit spread usually placed 3-6 months out in time in order to allow the market enough time to make its’ move.  Our preferred trade structure is to buy the long call at the money and sell the short call one strike price above the long call in the same month. 

The debit in the trade is the cost of the long call less the credit from the short call.  The maximum risk is the debit.  Maximum reward is the difference between the strikes of the spread less the debit.  Example:  A $5 spread with the long call at strike 20 with a cost of $3 and a short call at strike 25 at a credit of $1 resulting in a net debit of $2.  Since the spread is $5 ($25 less $20), the maximum reward is the difference in strikes less the debit or $2.  If the trader waits until expiration of the spread and assuming the stock is trading higher that the short call, the return is 150% ($2/$3). 

A more prudent approach may be to consider establishing a trade with a favorable position Delta.  The Long option Delta less the short option Delta should result in an attractive position Delta.  Let us assume for illustrative purposes that the long call has a Delta of .50 since it is at the money and the short call has a negative Delta of -.32.  That means the net position Delta is .18 (.50-.32).  The result is that for every $1 move in the stock, the total position will be worth $.18 more.  Knowing this, it is easy to establish an exit point as a percentage ROI.  If the net debit in the position is $2 as previously established, and the trader chooses to exit the position at a 20% gain instead of waiting for the spread to expire in 3-6 months, he/she can do so.  A 20% gain in our example would require the stock to go up a little over $2 ($2 net debit x .20% = $.40 gain on the $2 debit.  $.40/$.18 = $2.22 move).

Review the risk graph to gain further understanding of the risk and reward of the position.  Best, Robin

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