When first being introduced to option spreads for the first time, new traders often begin with the bull call and bull put spreads, which are bullish verticals spreads. Many individuals enter the options arena from an experience of traditionally buying and holding stocks, so the bullish spreads make more sense than the bearish spreads when they initially start their options trading approach. These types of spreads are referred to as vertical spreads since they combine long and short options with the same expiration dates. The term was coined because when you view an options table you will see that option prices for the same expiration date fall along a vertical line.
Before we get into the key comparison parameters, let’s quickly review the differences between the bull call spread and the bull put spread. The bull call spread is constructed by buying a lower strike call and selling a higher strike call with the same expiration date while the bull put spread is constructed by buying a lower strike put and selling a higher strike put with the same expiration date. The option strategist deploys both of these vertical spread strategies when they anticipate a moderately bullish market, however, the bull call spread is initiated at a net debit and the bull put spread is initiated at a net credit. A debit spread costs money, causing a deduction of funds from the trading account. A credit spread creates money, causing a credit being made to the trading account.
For comparison purposes we will only focus on the longer term bull call and bull put spreads, or, as they are sometimes to as, “wealth building strategies.” It needs to be noted here however that an option strategist can also use the bull put spread in a short-term time frame usually 45 days or less as a viable income type strategy. Assume a trader is moderately bullish on the XYZ Corporation and is looking to put on the best vertical spread possible. To do so the option strategist will have to carefully evaluate the risk graph, breakeven point as well as the associated risk to reward ratio.
To best illustrate this let us compare possible bull call and bull put strategies by looking at them using the Optionetics Platinum package, which is a leading options analysis tool. Figures 1 and 2 below provide the option strategist with all the information needed for a thorough comparative analysis of both spreads.
Figure 1: Bull Call Spread Risk to Reward Profile
Figure 2: Bull Put Spread Risk to Reward Profile
The first parameter the options strategist wants to analyze is the risk to reward or the Max Profit to Max Risk number. Next take a look at the breakeven point and then closely scrutinize the risk graph. Looking at the bull call spread the Max Profit to Max Risk parameter comes in at 122 percent with a breakeven of 52.25. The bull put spread has a Max Profit to Max Risk parameter that is 108 percent with a breakeven of 52.40. The risk graphs for both strategies look reasonable with not much difference from a comparative perspective.
Given this information the option strategist is probably best suited to choose the bull call spread primarily because of the 122 percent versus 108 percent Max Profit to Max Risk number. Keep in mind however when dealing with long term options that some brokers will give you some interest on the credit received which could change the comparison statistics. Be sure to check. The point to convey here is what type of analysis is necessary when comparing two closely related strategies like the bull call and bull put spreads. In future installments of Back to Basics we will discuss comparisons that would be classified under different categories but are similar in their bias or market expectation.
Happy Trading.
Jeff Neal
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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