As AAPL continues to move closer to the 405-strike, it becomes the at-
the-money option, with the dominant greeks. The gamma, theta, and vega
of the 405 call outweigh those of the ITM 395 call. Vega is more negative.
Positive theta now benefits the trade. The net gamma of the spread has
turned negative. Because of the negative gamma, the delta has become
smaller than it was when the stock was at $400. This means that the benefit
of subsequent upward moves in the stock begins to wane. Recall that there
is a maximum profit threshold with a vertical spread. As the stock rises
beyond $405, negative gamma makes the delta smaller and time decay
becomes less beneficial. But at this point, the delta has done its work for the
trader who bought this spread when the stock was trading around $395. The
average delta on a move in the stock from $395 to $405 is about 0.10 in this
case.
When the stock is at the 405 strike, the characteristics of the trade are
much different than they are when the stock is at the 395 strike. Instead of
needing movement upward in the direction of the delta to combat the time
decay of the long calls, the position can now sit tight at the short strike and
reap the benefits of option decay. The key with this spread, and with all
vertical spreads, is that the stock needs to move in the direction of the delta
to the short strike.
Strengths and Limitations
There are many instances when a bull call spread is superior to other bullish
strategies, such as a long call, and there are times when it isn’t. Traders
must consider both price and time.
A bull call spread will always be cheaper than the outright call purchase.
That’s because the cost of the long-call portion of the spread is partially
offset by the premium of the higher-strike short call. Spending less for the
same exposure is always a better choice, but the exposure of the vertical is
not exactly the same as that of the long call. The most obvious trade-off is
the fact that profit is limited. For smaller moves—up to the price of the
short strike—vertical spreads tend to be better trades than outright call
purchases. Beyond the strike? Not so much.
But time is a trade-off, too. There have been countless times that I have
talked with new traders who bought a call because they thought the stock