**Introduction**

Price spread strategy involves simultaneously buying and selling similar kind of options on the same underlying asset having same maturity/expiry date but with different strike price. That means, this strategy involves two option contracts with two different strike price creating a range having lower strike price and an upper strike price. This strategy is generally for those investors who have moderate price belief as it reduces the loss at the cost of limited gain.

Bullish CALL Price Spread involves buying a CALL option at lower strike price and simultaneously selling/writing a CALL option at a higher strike price on the same underlying asset having same maturity/expiry date.

**Let us understand what is bullish CALL spread strategy using an example-**

Consider an investor who is bullish on stock and expects the share price will rise above $500. His investment horizon is 1-year. Following information is available â€“

Share price is currently trading at $480

Call option at strike price of $500 is currently trading at a premium of $60.85

Call option at strike price of $580 is currently trading at a premium of $34.27

**Case â€“ 01: Buying a **__CALL Option__

Investor is bullish on stock and expects the share price will rise above $500 on expiry. He can simply buy a CALL option at a strike price of $500 by paying premium of $60.85.

Initial premium outflow = $60.85.

Break-even point = Strike price + Initial premium paid = $500 + $60.85 = $560.85

**Situation â€“ 01: If the share price on expiry happens to be $450**

CALL option lapses.

Payoff on expiry would be $0

Loss on expiry would be initial premium paid = $60.85

**Situation â€“ 02: If the share price on expiry happens to be $570**

CALL option gets exercised in favour of the investor.

Payoff on expiry would be share price minus strike price = $570 - $500 = $70

Profit on expiry would be payoff minus initial premium = $70 - $60.85 = $9.15

**Situation â€“ 03: If the share price on expiry happens to be $600**

CALL option gets exercised in favour of the investor.

Payoff on expiry would be share price minus strike price = $600 - $500 = $100

Profit on expiry would be payoff minus initial premium = $100 - $60.85 = $39.15

**Situation â€“ 04: If the share price on expiry happens to be $700**

CALL option gets exercised in favour of the investor.

Payoff on expiry would be share price minus strike price = $700 - $500 = $200

Profit on expiry would be payoff minus initial premium = $200 - $60.85 = $139.15

Therefore, under CALL option

Maximum Loss = Initial premium paid = $60.85 [ maximum loss is limited ]

Maximum Profit = Share price â€“ Initial premium paid [ maximum profit is unlimited ].

Break-even point = Strike price + Initial premium paid = $500 + $60.85 = $560.85

**Case â€“ 02: Simultaneously buying and selling CALL Options**

Investor is bullish on stock and expects the share price will rise above $500. At the same time he is non-bullish above $580. This means that the investor is expecting the share price will remain between $500 and $580 on expiry. He can do so by buying a CALL option at a strike price of $500 by paying premium of $60.85 and simultaneously sell/write a CALL option at a strike price of $580 for which he will receive CALL premium of $34.27.

Initial premium of $60.85 involves right to have option above $580. Since investor is non-bullish on stock above $580, why to pay additional cost of holding the position? Therefore, selling/writing a CALL option at a strike price of $580 will result in initial premium inflow of $34.27

Net initial premium outflow = Premium paid on $500 CALL â€“ Premium received on $580 CALL = $60.85 - $34.27 = $26.58.

Break-even point = Lower strike price + Net initial premium paid = $500 + $26.58 = $526.58.

**Situation â€“ 01: If the share price on expiry happens to be $450**

Both CALL option lapses.

Payoff on expiry would be $0

Loss on expiry would be net initial premium paid = $26.58

**Situation â€“ 02: If the share price on expiry happens to be $570**

$500 CALL option gets exercised in favour of the investor while $580 CALL option lapses.

Payoff on expiry on $500 CALL option would be share price minus strike price = $570 - $500 = $70

Profit on expiry would be payoff minus net initial premium paid = $70 - $26.58 = $43.42

**Situation â€“ 03: If the share price on expiry happens to be $600**

$500 CALL option gets exercised in favour while $580 CALL option gets exercised against the investor.

Payoff on expiry on $500 CALL option would be share price minus strike price = $600 - $500 = $100 (exercised in favour)

Payoff on expiry on $580 CALL option would be share price minus strike price = $600 - $580 = $20 (exercised against)

Therefore, net payoff from the strategy = $100 - $20 = $80

Profit on expiry would be net payoff minus net initial premium paid = $80 - $26.58 = $53.42

**Situation â€“ 04: If the share price on expiry happens to be $700**

$500 CALL option gets exercised in favour while $580 CALL option gets exercised against the investor.

Payoff on expiry on $500 CALL option would be share price minus strike price = $700 - $500 = $200 (exercised in favour)

Payoff on expiry on $580 CALL option would be share price minus strike price = $700 - $580 = $120 (exercised against)

Therefore, net payoff from the strategy = $200 - $120 = $80

Profit on expiry would be net payoff minus net initial premium paid = $80 - $26.58 = $53.42

Therefore, under Price Spread Strategy

Maximum Loss = Net initial premium paid = $26.58 [ maximum loss is limited ]

Maximum Profit = Difference of strike price â€“ Net initial premium paid = ($580 - $500) - $26.58 [ maximum profit is limited ].

Break-even point = Lower strike price + Net initial premium paid = $500 + $26.58 = $526.58.

**Benefits of Price Spread Strategy**

Under situation â€“ 01 of both the cases, the loss of initial premium paid is lower in Price Spread Strategy as compared to buying only CALL option in case â€“ 01 [ lower initial premium resulting in lower loss ].

Under situation â€“ 02 of both the cases, the profit from the Price Spread Strategy is higher as compared to buying only CALL option in case â€“ 01 [ higher profit on expiry because of lower initial premium ].

Under situation â€“ 03 of both the cases, the profit from the Price Spread Strategy is higher as compared to buying only CALL option in case â€“ 01 [ higher profit on expiry because of lower initial premium ].

Break-even point in Price Spread Strategy is less as compared to buying only CALL option in case â€“ 01 [ faster break-even because of lower initial premium ].

**Drawbacks of Price Spread Strategy**

Under situation â€“ 04 of both the cases, the profit from the Price Spread Strategy is lower as compared to buying only CALL option in case â€“ 01 [ lower profit on expiry because of loss in writing a $580 CALL option ].

**Recommendation to the investor**

Bullish CALL Price Spread Strategy should only be employed if an investor expects the share price to remain between a particular range of strike price (in our case, $500 to $580). If the share price rises steeply (say share price on expiry rises to $700, $800 . . . and so on), the profit from the Price Spread Strategy is limited to $53.42 while in case â€“ 01 i.e., buying only CALL option can result in unlimited profit.

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