What is a long call spread?
A long call spread is a type of debit spread – a term by which this type of trade is also known – because at trade entry, you need to pay a debit. In this spread, you buy a call option and sell a call option with a higher price. This strategy takes advantage of an increase in the price of the underlying asset before it expires. Increased implied volatility may also benefit a long call spread position.
A long call spread is created when you buy a call option and sell a call option with a higher strike price. The maximum risk for this trade is the amount you pay for it. The maximum profit potential is the difference between the strike prices of the two options minus the premium paid. To break even on this position, the stock price must be above the long call option by at least the amount you paid to enter this trade.
The nearer the strike prices are to the price of the underlying stock, the more debit a trader will have to pay. This means that a long call spread composed of a strike price close to the underlying will cost more money, but there is also a higher chance that the option will finish in-the-money. The larger the spread width between the long call and the short short, the more premium will be paid. This means you will have to pay more money, but you can also make a lot of money if things go well.
When to use a long call spread strategy
Traders enter a long call spread when they believe that the underlying asset price will increase before the expiration date of the call options. The risk of this position is limited to the amount of debit you pay when you enter. The further out-of-the-money the long call spread is when initiated, the more aggressive the outlook on the trade.
How to manage a long call spread position
The net effect of time decay is more or less neutral. Time decay will cause the option you bought to lose value, which isn't good. But it also means that the option you sold is losing value, which is good.
The effect of implied volatility on a stock's price depends on how close the stock is to your strike prices. If you think that the stock price will go up, you want the implied volatility to decrease. This is because it will make the option you sold (that is close to the current stock price) worth less than the option you bought (which is further in the money). This will increase how much money you make from the trade.
If the stock price falls and is approaching or below the strike price of your first option, you want implied volatility to increase. This will make the option you bought more valuable than the option you sold. And it will increase the overall value of your spread.
Long call spread maximum profit potential
The potential profit for this trade is the difference between the strike prices of the two options minus the debit you paid to enter the trade.
Long call spread maximum loss potential
The most you can lose is the amount of money you paid for the option.