outcomes at expiration—above or below the strike—this spread has three
possibilities: below both strikes, between the strikes, or above both strikes.
In this example, if Apple is below $395 at expiration, both calls expire
worthless. The rights and obligations of the options are gone, as is the cash
spent on the trade. In this case, the entire debit of $4.40 is lost.
If Apple is between the strikes at expiration, the 405-strike call expires
worthless. The trader is long stock at an effective price of $399.40. This is
the $395-strike price at which the stock would be purchased if the call is
exercised, plus the $4.40 premium spent on the spread. The break-even
price of the trade is $399.40. If Apple is above $399.40 at expiration, the
trade is profitable; below $399.40, it is a loser. The aptly named bull call
spread requires the stock to rise to reach its profit potential. But unlike an
outright long call, profits are capped with the spread.
If Apple is above $405 at expiration, both calls are in-the-money (ITM).
If the 395-strike calls are exercised, the trader buys 100 shares of Apple at
$395 and these shares, in turn, would be sold at $405 when the 405-strike
calls are assigned, for a $10 gain per share. Subtract from that $10 the $4.40
debit spent on the trade and the net profit is $5.60 per share.
There are some other differences between the 395–405 call spread and the
outright purchase of the 395 call. The absolute risk is lower. To buy the
395-strike call costs 14.60, versus 4.40 for the spread—a big difference.
Because the debit is lower, the margin for the spread is lower at most
option-friendly brokers, as well.
If we dig a little deeper, we find some other differences between the bull
call spread and the outright call. Long options are haunted by the specter of
time. Because the spread involves both a long and a short option, the time-
decay risk is lower than that associated with owning an option outright.
Implied volatility (IV) risk is lower, too. Exhibit 9.2 compares the greeks of
the long 395 call with those of the 395–405 call spread.
EXHIBIT 9.2 Apple call versus bull call spread (Apple @ $391).
395 Call395–405 Call
Delta 0.484 0.100
Gamma0.00970.0001
Theta −0.208−0.014
Vega 0.513 0.020