Bull Spread - Long Call Spread

Bull Spread

Long Call Spread

When to use : Bullish Trend
How to establish : LONG a Call and SHORT a higher strike Call
Debit or Credit : Debit
Margin Requirement : No
What is the Maximum Profit : The distance between the LONG and SHORT Strikes (limitted)
What is the Maximum Loss : Amount paid (the debit) for the spread (limited)

Example :

RIMM is currently at $121.10 in early Sept
You expect RIMM to rally and have reasons to believe that it will have the potential to increase its share price to a maximum of $130, in the near term.
You then contemplate a bullish option position, since it is too capital intensive to pay $12,110 for 100 shares of RIMM.

You could just simply buy a Call option on RIMM, which will give you unlimited profit potential if RIMM price rallies extraordinarily. However, you are concerned about time decay on this position that is soon expiring. The current implied volatility is also high given a volatile market in the recent days. These 2 GREEKS will work against a simple Long Call position. Besides, it is also expensive to just buy a Call option.
Fyi, 1 contract of option is equal to right to trade 100 shares of the stock.

So, you decide to purchase a Sept 125 Call and sell a Sept 130 Call option spread. This is effectively, a Long Call Spread.

This Long Call Spread, gives you the right to buy RIMM at $125 and the potential to sell RIMM shares at $130, for which you pay a premium (equals to the amount of debit paid for this spread)

This position is similar to a Long Sep125 Call, but limits its upside profit potential when RIMM reaches $130. Consequently, for this reduced profit potential, you pay a smaller debit for this spread, and hence reduce your risk for this trade. Makes sense, since lower reward must be matched by a lower risk.
In this example, the premium(debit) of this spread is 1.50 (i shall only use unit rather than actual $ amount in all my examples)

Position yields maximum profits when RIMM shares are at or above 130 at expiration. The maximum profit potential is 130 - 125 net off debit paid. The breakeven point for this trade, at expiration, is 126.50 (125 + 1.50). Hence, at expiration, if RIMM settles anything below 126.50, a loss is experienced. The maximum losses will be limited to the premium of 1.50 paid and happens RIMM shares falls below 125 at expiration.

Profit/Loss Explanation :

(you will have to assume that these premiums are accurate)
Debit (means you pay) for Long Sept 120 Call = -3.30
Credit (means you receive) for Short Sept 130 Call = 1.80
Total Debit = 1.50

Maximum loss = 1.50
Maximum Profit = 3.50 ( 130 - 125 - 1.50)
Breakeven point = 126.50
Profit Range = anything at and above 126.50

Risk/Reward Ratio = 1.50 / 3.50 = 0.43; ie you risk 0.43 for a profit potential of 1.00

The profit and loss is illustrated using the chart below