What changes in my calculations when one leg of a bull spread is short?
I understand the intuition of a bull spread, but I still make sign mistakes once the higher-strike call is written instead of purchased.
The short leg turns part of the upside into a negative payoff for your strategy once that option finishes in the money.
Example with Harbor Vision Media:
- Long call, strike
65, premium5 - Short call, strike
75, premium2
If the stock ends at 82:
- Long 65 call value =
17 - Short 75 call value =
-7 - Net expiration value =
10
Then include premiums:
- Net premium paid =
-5 + 2 = -3 - Profit =
10 - 3 = 7
The short higher-strike call does two things:
- It lowers the upfront cost.
- It caps the payoff beyond the higher strike.
That is why the bull spread is cheaper than a naked long call, but it also gives up unlimited upside.
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