Bull Call Spread
Risk: low
Reward: low
General Description
Entering a bull call spread position entails buying a call option (preferably in-the-money) and selling an out-of-the-money call option.
The Thinking
This strategy is employed when you are generally bullish but don't think the stock will rally too much. Essentially you are buying calls because you think the underlying issue will rally, but since you don't think it will rally too much, you sell an out-of-the-money call to lower your risk by locking in your max loss at a lower price.
Example
Let's say DELL is trading @ 26.85. You are bullish and think the stock will rally a few points, but you don't think it will catapult higher. You buy the 25 (in-the-money) calls for $2.95 and sell the 30 (out-of-the-money) calls for $0.50.
Selling the calls reduces your risk because you max loss is locked in place at a lower price than if you had only bought the calls. In exchange for wanting lower risk, you forego whatever profits you would have enjoyed if the stock rallies above 30. Your max profit occurs at 30; above 30 the long and short call positions will cancel each other out. You max loss is locked in place at the onset. It is the amount you paid for the 25 calls minus the premium collected from selling the 30's.
The image below summarizes the trade with a P/L Diagram.
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