Bull Call Spreads for Big Gains on Small Moves

Zack's know your options a weekly overview of unique option strategies and ideas designed to help you beat the market no matter which direction it's going let's talk about bull call spreads now with our options guru Kevin matrice who joins me actually bull call spreads in the context of big gains on small moves now you and I have never talked about this before but this is a strategy that you use yeah it's weird because you know we've been doing these no your option pieces for quite some time and I don't think I ever really did a piece on bull call spreads but I use this strategy very very often so I figured now would be a really good time to do it plus two I just put a bunch of bull call spreads on and we're going to talk about that today but a bull call spread involves buying a call option and then simultaneously selling a higher strike call against it this is put on as a debit and as the name suggests it is a bullish strategy the caveat though is that it does have a limited profit potential so in this respect I think this is why bull call spreads may not be as exciting to some investors as just buying a long call because right somebody buys a long call they fantasize the stock is going to skyrocket and they're going to make gobs of money but but how often does that happen and this is one of the benefits of using a bull call spread so so maybe not as as popular because everybody expects their stocks to skyrocket yeah everybody does and so they just want to go straight long because there's unlimited profit potential when you just have a straight long call there's no camp but most of the time stocks don't skyrocket and if the stock ends up making a more mediocre move and let's say it takes longer for that move to happen the problem is that the options purchaser is always having to worry about time decay so if time ticks away if you're in a stock and you just see the stock go sideways and base for a little bit no big deal once the the stock starts moving up you're fine but with an option every single day that underlying stock doesn't do anything it's eating away at your premium the benefit with the bull call spread is that since you wrote an option against it that kind decay is actually working in your benefit so that's another benefit of having a bull call spread as opposed to just purchasing a long call you also say it's a good way to be able to get into options for lesser money yet the you know you take a look at some of the very very popular stocks some of these stocks are trading at hundreds of dollars which makes a lot of these options decent options go for two thousand three thousand ten thousand dollars and it's hard to pay that kind of money for an at the money option let alone an out of the money option and these ridiculous prices oftentimes will keep the options purchaser from getting into these opportunities these are great opportunities if you could only figure out a strategy to be able to get into it but again if you are buying a ridiculously priced option when you're selling the one above it you're also collecting premium on that wildly overpriced option so the net result is that you can actually get yourself into that exciting stock for a fraction of the cost of what it would take to get into a long call alright give us some examples yes so let's take a look at an example now I just did a bull call spread in Tesla Motors and Tesla Motors when I put it on was trading at one hundred and eighty four dollars now I put this spread on on February third of 2014 so that was like what week and a half ago or something like that it was a number one ranked stock Zacks ranked number one it looked fantastic I had to get in so is that a 180 for bucks but the problem was that the call options were just ridiculously expensive the 185 call was going for 22:02 in other words it was costing two thousand two hundred and two dollars in fact it's right here on the screen so the bull call spread I ended up buying was this I bought the June 1 85 call at 2,200 bucks but I simultaneously sold the June 1 95 at 1824 in other words I collected a credit of eighteen hundred and twenty-four dollars so my total cost to get into this bull call spread was three hundred and seventy eight bucks so remember if I had only bought that long call I would have had to have invested twenty-two hundred bucks 22:02 whereas here I only had to pay three hundred and seventy eight bucks and you're making money huh so here's how we make money so I got a couple of scenarios scenario one if Tesla at expiration and for this June spread I've got four and a half months so it's going to expire the third Friday in June is for only a half months from where we are if it were to go up to 195 the 185 call would be worth ten dollars which is equivalent to a thousand dollars because that option is now ten dollars in the money that would actually generate a loss of twelve hundred and two dollars but the 195 call that I wrote would now be worth zero because it's out of the money which means I would keep the entire 18 hundred and twenty-four dollars I collected so I made eighteen twenty-four on that call add those two things together and I have a gain of six hundred and twenty-two dollars on an investment of only three hundred and seventy eight bucks that's a one hundred and sixty four percent gain and the stock right it was at 184 all it had do is get to 195 the stock literally only had to move just less than six percent in order for me to make this game alright scenario two yep now let's say at expiration let's say Tesla were to make a very sharp move let's it goes a 225 250 whatever sharply above 195 the 185 call would now be worth $4,000 because now it is $30 in the money that is 1798 profit on the call 1798 dollars on that call however the 195 call would now be worth $3,000 which means I would have a loss of eleven hundred and seventy-six dollars but again if you add those two together it still comes out to a gain of six hundred and twenty two dollars now it should be noted that if Tesla skyrockets the short call at 195 does limit your games but even though you are precluded from making any more than 622 you still made 622 and you still hate a one hundred and sixty four percent gain pretty awesome alright you got a couple more to go through scenario three let's say Tesla ends up closing pretty much where you were when you got into it let's say 185 okay let's say close that 185 below my lowest strike the 185 call would now be worth zero which means I've lost all that I paid for it I've lost 2200 bucks the 195 call would also expire worthless meaning I would keep the 1824 dollars I collected as my profit on that one but again add those two together and you get a loss of 378 so my loss is always limited to what I paid for the spread in the first place now if Tesla were to close one dollar above my lowest strike now instead of losing 2202 I'm only losing 21 - which means my loss is no longer 378 now it's only 278 if it closed at 187 now my loss is only 178 knowing that we paid 378 for this spread my break-even point comes in at 188 78 so all Tesla really had to do is go to 188 78 and I won't make anything but I also won't lose anything and as it keeps on going up from there I will make a proportional profit but when it gets to 195 or higher I am capped out but again I still have a potential 622 bucks pretty cool here's the last scenario let's just say Tesla plummets it closes below 185 let's say closes at 100 or somehow they bankrupt the company doesn't matter take your worst-case scenario possible if Tesla were to close below our lowest strike I am still only going to lose 378 bucks so I have a very small investment tiny amount at risk but I have a pretty good profit potential and that's what makes it exciting all right those are a lot of scenarios yeah sum it all up all right here's the summation so let's just review what happens when you're doing a long call if you did a long call if you bought the June 1 85 when Tesla was trading at 184 that would have cost you 20 200 and $2.00 Tesla would have to climb to 207 Oh - just to break even that means you would need a 12 and a half percent move to not lose any money it would also have to go up to 200 and $13.24 in order to make 622 bucks so you would need a fifteen point eight nine percent move to generate a twenty eight percent return on that investment your max risk though is still twenty two hundred and two bucks for the bull call spread here's what it looks like the June 185 195 bull call spread costs three hundred and seventy eight bucks Tesla would only need to get to 188 78 to break-even so I only needed 2.6 percent move in order to to break-even to achieve my maximum profit potential it would need to get to 195 but that's only a five point nine eight percent move to make a $622 gain which is a one hundred and sixty four percent return and again my max risk is only three hundred and seventy eight bucks so if you do the math you'll realize the math usually looks phenomenal with a bull call spread and I will say when I came down here today Tesla was trading over two hundred bucks now Tesla doesn't have to do anything else it can even go back down to 195 and if it stays above 195 right now it's at 200 bucks at mid-june right third Friday in June that spread will net me a gain of six hundred twenty two dollars it's painless I don't have to worry about what's happening and I just think it is a fantastic way to go and if you're looking for a way to get into you know very expensive stocks or if let's say you have a mildly bullish outlook on something where you only expect to see a small move you can really really take advantage of these types of things with a bull call spread and I highly recommend this strategy alright and today is actually code for intraday February the 13th there you go yeah okay and you can track out some other options information fact there's a text version of this particular explanation of the bull call spread on our website at Saks com in the options section of the website but there's also other options information that's in that option section of Zacks comm as well so if you're not there already watching this video get on over and link to it all right off the homepage this information and other stuff you'll find in the options section of the website all information to help you know your options with Kevin matrice I'm Terri roof low you

Channel: Zacks Investment Research

Views: 83,842

Keywords: Zacks, Zacks Investment Research, Kevin Matras, Know Your Options, Market

Id: mMWhQnbt-F8

Length: 13min 17sec (797 seconds)

Published: Thu Feb 13 2014