Both the bull call spread and bull put spread produce a limited profit with limited risk on a rise in the price of the underlying security. However the former is a debit spread which decreases value over time and on an decrease in implied volatility; the latter is a credit increases in value over time and on a decrease in volatility.
First let’s look at what each these vertical spread strategies entails:
Bull Call Spread
A bull call spread involves the purchase of a (usually out of the money) call option, partly financed by the sale of a call with a higher strike price but the same expiration date. It is a debit spread (it involves a cash outlay).
Here’s the P&L diagram:
A trader would put this spread on if they believed that the stock would rise, but was unwilling to risk losing all their call premium investment should the trade go against them. Thus they are willing to give up some of the upside to protect the trade.
Another way of looking at this is with reference to the options greeks.
A call option is strongly delta positive (ie it is sensitive to stock price movements). The sale of the call option, making a bull call spread, reduces the delta of the trade, and hence minimises the loss should it go against the investor.
A more subtle risk is vega, the sensitivity to changes in volatility. A call option is vega positive; it rises in value with a rise in implied volatility (and vice versa).
Unfortunately volatility tends to fall as stock prices rise, reducing the gains to a long call should the stock rise. Again the sold option reduces the position’s vega, reducing this effect.
Again a long call has negative theta – it falls in value over time – but this is mitigated by the sale of the call to make a bull call spread.
Bull Put Spread
A bull put spread involves the sale of a (usually out of the money) put option combined with the purchase of a further out of the money put. It is a credit spread – a net premium is received.
Here’s the P&L Diagram:
As with the bull call spread the trader believes the stock will rise hence he/she will get to keep the premium earned.
Some of the greeks, however, are different:
This is the same as before: the spread is delta positive but less so than the outright purchase of the put.
The spread is now vega negative: as volatility rises the options’ values fall which, given the trader has sold them for a net credt, this is good news.
Therefore as the stock rises, and volatility falls, the spread falls in value (again, good news). This increases the spread’s profitability (but also the risk – if the stock were to fall, volatility would rise and the options rise in value).
Unlike before, theta works in the trader’s favor: the bull put spread is theta positive. As time passes the spread increases in profitability.
Bull Call Spread Vs Bull Put Spread
Here then are the similarities and differences of these two options strategies:
- Both spreads have similar P&L Diagrams: they make a limited profit/loss if the stock price rises/falls.
- Both are delta positive: they are put on should a trader expect a stock to rise.
- Both a limited risk strategies: their downside is limited (at a cost of a limited upside)
- The bull call spread is a debit spread, whereas the bull put spread is put of for a net credit
- The bull call is vega positive: it increases in value with increases in volatility. Whereas volatility increases reduces the value of a bull put spread.
- The bull call theta negative: it loses value over time; the bull put spread increases in value over time.
So Which Is Better?
As with most options related question, the answer is ‘it depends’.
Some options traders are happier with the relatively easy to understand debit spread; others love to see the value of the their credit spreads increase over time.
Whichever one you chose, be careful to understand risks – especially the more subtle options greek risks – beforehand.