Equity and Index Options Explained

13

Long Call Spreads (Bull Call Spreads)

GLOSSARY

Vertical spread: an option strategy comprising options with the same expiry dates but different strike prices

Leg: a constituent part of an option spread

Bull spread: an option spread designed to exploit a bullish (i.e. upward) view on the underlying

What is a call spread? A call spread consists of two “legs”, a long call “leg” and a short call “leg”. A long call spread, sometimes called a bull call spread (because it is bullish in nature) consists of a long call with a lower strike and a short call with a higher strike.

For example, from the matrix of Sep BP option prices (Table 12.5), buying the 540/560 call spread consists of two legs, buying the 540 call at 19 and simultaneously selling the 560 call at 12. The cost of the call spread is 7 ticks (equivalent to £70) per call spread, the difference between the 19 ticks paid for the 540 call and the 12 ticks received from the sale of the 560 call. These 7 ticks represent the maximum loss on buying the call spread. If BP is at or below 540 (i.e. £5.40) on Sep expiry, then both the 540 and 560 calls will expire worthless. The maximum possible value of the call spread is 20, the difference between the two strike prices of 540 and 560. If BP is at or above 560 (i.e. £5.60) on Sep expiry, then the 540 call will be worth exactly 20 more than the 560 call.

For example, if BP is priced at exactly 560 (i.e. £5.60) on Sep expiry, then the 540 call will be worth exactly 20 and the 560 call ...