A bull spread provides the greatest profit potential when the underlying stock's market value rises. With the bull spread, you buy an option with a lower striking price and sell another with a higher striking price. You can employ either puts or calls in the bull spread.
This example describes the ideal situation, in which both sides of the spread are profitable, because the stock's price behaves perfectly to suit the spread. Of course, you have no control over price movement, so this outcome will not always occur.
[caption id="attachment_12545" align="aligncenter" width="470"] Example of bull spread.[/caption]
ExampleBull Spread, Not a Bad Thing: You open a bull spread using calls. You sell one December 55 call and buy one December 50 call, as shown in Figure above. At the time of this transaction, the underlying stock's market value is $49 per share. After you open the spread, the stock's market value rises to $54 per share. When that occurs, the 50 call increases in value point for point once it is in the money. The short 55 call does not change in value as it remains out of the money and, in fact, will drop in value as its time until expiration nears. Because of the advantage the spread creates at the time the stock has reached the $54 per share level, both sides of the spread will be profitable. The long 50 call rises in value and the short 55 call remains out of the money.
Smart Investor TipThe spread is most profitable when the stock's price changes in the desired direction, timing, and pattern. Both sides of the spread can work out well. This would be much easier if stock price movement could be controlled or predicted -- which it cannot.
A bull vertical spread with defined profit and loss zones is shown in Figure below.
[caption id="attachment_12546" align="aligncenter" width="300"] Bull vertical spread profit and loss zones.[/caption]