What is a call spread?

A call spread is something people do with stock options. It’s when you buy one kind of option called a “call” and sell another kind of call option at the same time. The two call options you get have the same expiration date. That means they both end on the same day.

But here’s the key part – the call options have different strike prices. The strike price is the price where the option can be used to buy the stock. You buy the call option that has a strike price closer to the current stock price. And you sell the call option that has a strike price further away from the stock price right now.

Bullish call spreads

When you buy the call option with the strike price closer to the current price and sell the one further away, it’s called a “bullish call spread”. Bullish means you think the stock price will go up. You make the most money if the stock price goes above the strike price of the call option you bought. But not crazy high above it.

See, your profit is limited. It can only be as much as the difference between the two strike prices minus what you paid for the spread. You sold that other call option, remember? The one with the higher strike price. If the stock rockets past that higher strike price, the option you sold caps off your gains.

Bearish call spreads

Now when you flip it around and sell the call option with the lower strike price and buy the higher one, it’s a “bearish call spread”. Bearish means you think the stock price is going to drop or at least not go up much.

The most you can make on the bearish spread is what you got paid when you sold it. That’s the best case if the stock stays below the lower strike price. The call option you sold will expire worthless. You keep the cash. Nice.

But careful. Your losses are capped at the difference between the strike prices minus what you got paid upfront. If the stock jumps up a lot, past the higher strike price, ouch. Both options will be worth something and you’ll be out some cash.

The good and bad of call spreads

Define your risk

The nice thing about call spreads is you know right from the start what the most is you can make or lose. Your max profit and loss are defined. The spread between the two strike prices minus what you paid for a bullish spread or got paid for a bearish spread. That’s it.

Options can be risky because you might lose a lot more money than you expected if the stock moves against you. But with spreads, you know your max pain right off the bat. You’re not going to wake up to a surprising margin call.

Cheaper than plain options

Another good part about call spreads is they usually cost less than just buying or selling a call option by itself. The option you buy and the one you sell kind of offset each other.

Like if you’re bullish, a plain call option might cost $500. But if you turn it into a spread by selling a higher strike call for $300, now the spread only costs you $200 total. Or if you’re bearish and sell a call option for $500, you can limit your risk by buying the higher strike for $300. You get $200 in your pocket.

But your profit is limited too

The tradeoff is your potential gain is capped. With the bullish spread, your profit maxes out at the higher strike price. And the bearish spread caps how much you can make to what you got paid to sell it.

If you just bought a call option and the stock soared, you could make way more money. Or if you only sold a call option, you’d get a bigger payment up front.

So it limits both your profit and your loss. You gotta decide if the tradeoff is worth it to you. Maybe you’re OK with a smaller win if it means you can’t lose your shirt.

You might lose it all

One big bummer about call spreads is you might lose the whole thing. Like the whole amount you paid for a bullish spread or the entire max loss on a bearish spread. It’s not so common for plain call options to go to zero. But with spreads it can definitely happen.

Why? Because both options are the same type, calls in this case. With spreads that mix calls and puts, one side can gain value while the other loses. But with call spreads, if the stock goes the wrong way, both options lose value. The whole spread can just poof, be worth zero.

When to use call spreads

You’re pretty sure about the direction

Call spreads can be a good choice if you have a strong feeling about where the stock is headed. If you’re confident it’s going up, a bullish call spread could be smart. You’ll make money even if it only goes up a little. And if you’re sure it’s going down, a bearish call spread lets you profit off that.

Just remember, you gotta be right. If the stock goes the opposite of what you thought, your spread could end up worthless real quick. No take backs on those.

You want to control your risk

Spreads can help you sleep at night. You know exactly how much you could lose right when you enter the trade. No surprises. That can be comforting if you’re not into nail biter trades.

Especially if the stock is being a drama queen with crazy swings, a spread helps keep you above water. You might not make a killing but you won’t get killed either.

You don’t have a ton of cash

Let’s be real, options aren’t cheap a lot of the time. But call spreads usually have a lower price tag than lone options. So if you’re light in the wallet, spreads might be the way to go.

You can take advantage of the leverage of options without putting up as much capital. Spreads are also a way to play pricier stocks you might not be able to afford otherwise.