The bull call spread has a long name but is nevertheless fairly easy to understand. As you can tell from its name, it's a bullish strategy and is made up of call positions. Its bearish cousin is the bear put spread.
I've compared buying a single long call option to playing a slot machine. The potential payout can be very high, but you can easily lose most if not all of your risked capital.
The bull call spread, however, still allows you to make some lucrative returns on a bullish bet, but it reduces the amount you have to risk in order to do so. The trade off? Your potential returns are capped rather than theoretically being infinite.
My analogy for the bull call then is more like buying a lottery ticket as part of an office pool - you have a better chance of winning, but if you do win big, you won't be keeping the payout all to yourself.
The price you pay for the long call (which you purchased) at the lower strike price is reduced by the premium you receive from the short call (which you sold) at the higher strike price. Since the premium paid is more than the premium received, the trade produces a net debit.
You can think of a bull call spread in a couple of different ways. For example, it's fair to consider it as essentially a long call with some of the risk removed. As I mentioned earlier, the trade off is that the explosive upside potential has also been removed.
A second comparison is to that of a covered call. A covered call consists of a short call sold or written against a long stock position (100 shares of the underlying stock). A bull call functions similarly, with the long call taking the place of the actual shares.
Finally, by writing the second call at a higher strike price, you've achieved two important things:
Let's suppose you're bullish on that old favorite of ours, the XYZ Zipper Company which is currently trading around $40/share. You're confident that the stock will be trading higher in the near term, although you're not necessarily expecting a huge jump in the share price.
After considering your options, you choose to set up a bull call spread.
You simultaneously purchase a $40 call and sell a $45 call. Both options expire in one month. The long $40 call costs you $1.50/contract (or $150 excluding commissions) and for the $45 call that you sell, or write, you receive $.50/contract (or $50 excluding commissions).
The trade, therefore, costs $100 to set up ($150 debit less the $50 credit).
KO - 100 shares
GIS - 25 shares
JNJ - 25 shares
PAYX - 25 shares
TGT - 50 shares
Open Market Purchase Price: $11,195.23
Less Booked Option Income: $6235.40
Tot. Discount: 55.70%
Adj. Div. Yield: 7.50%