Core logic: trading cost for safety

The essence of the bull spread strategy is to use premium hedging to exchange for certainty of return. When investors expect the price of the underlying asset to rise moderately, but are unwilling to bear the full cost or unlimited risk of buying options unilaterally, they can lock the gains and losses in a controllable range by simultaneously buying low-strike options and selling high-strike options. This strategy is like "climbing with a safety rope" - you can enjoy the rising returns while avoiding the risk of falling off a cliff.

Take the US stock market as an example: Assuming that Apple's stock price is currently $180, investors believe that it will rise to $195 in the next month, but the probability of breaking through $200 is low. At this time, you can buy a call option with an exercise price of $170 (premium of $12) and sell a call option with an exercise price of $190 (premium of $5), with a net cost of $7.

If the stock price rises to $195 at expiration, the low-strike option will earn $25, the high-strike option will be worthless, and the net profit will be $18 (25-7); if the stock price falls below $170, only $7 in premium will be lost. This "offensive and defensive" feature makes it a classic tool for volatile upward markets.

Construction method: Build a profit ladder in three steps

Step 1: Anchor the target and direction

Choose assets with sufficient liquidity and clear trends. For US stocks, it is recommended to choose large-cap stocks or index ETFs (such as S&P 500 options). For the crypto market, it is recommended to focus on mainstream currencies such as Bitcoin.

Step 2: Design the strike price interval

The low strike price is usually close to the current price (at the money or slightly out of the money), and the high strike price is set according to the expected increase. In experience, the price difference of individual US stocks is set at 5-10% of the current price, and assets with higher volatility such as Bitcoin can be relaxed to 15-20%. For example, if the price of Tesla is $800, buy a call option with a strike price of $820 and sell a call option with a strike price of $880. The spread of 7.3% can both cover the expected increase and retain a safety margin.

Step 3: Calculate costs and break-even point

Net cost = Buy option premium - Sell option premium. Breakeven point = Low strike price + Net cost.

Take Bitcoin options as an example: buy a call option with an exercise price of $62,000 (premium $4,000), sell a call option with an exercise price of $68,000 (premium $1,500), net cost $2,500. The break-even point is $62,000 + $2,500 = $64,500, and the price of the currency must break through this point to make a profit.

Risk-return ratio: a balancing act on a knife's edge

The maximum profit of the bull spread strategy = high strike price - low strike price - net cost, and the maximum loss = net cost. This characteristic of "profit has a ceiling and loss has a bottom" makes it show unique value in three scenarios:

1. Cautious Gambling in the Earnings Season Before Microsoft released its earnings report in April 2024, the stock price was consolidating at $420. Investors bought call options with an exercise price of $425 (premium of $10) and sold call options with an exercise price of $445 (premium of $4), with a net cost of $6. After the earnings report, the stock price rose to $438, the low-exercise option made a profit of $13, and the high-exercise option was still out-of-the-money, with a net profit of $7 (yield of 117%), far exceeding the 4.3% increase in the stock price.

2. Seeking progress in the crypto cycle Bitcoin is often accompanied by violent fluctuations before halving. When the price of the currency fell back from $72,000 to $65,000 in March 2024, a call option with an exercise price of $68,000 (premium of $5,000) was bought, and a call option with an exercise price of $75,000 (premium of $2,000) was sold, with a net cost of $3,000. After the halving, the price of the currency rebounded to $71,000, and the low-exercise option made a profit of $3,000. After hedging the cost, the profit and loss just broke even, avoiding the embarrassment of spot holders "working in vain after the price rose".

3. Dynamic position adjustment for breakthroughs If the underlying asset unexpectedly rises sharply, you can close the high strike price options in advance to release profits. For example, Coinbase's stock price started to rise from $80, and investors originally planned to take profit at $100. However, after the stock price broke through $110, they closed the $120 call option they sold and kept the $100 call option they bought. They then took profit at $130, increasing their yield by 40%.

Advanced skills: Let the strategy breathe the pulse of the market

Volatility timing: It is more cost-effective to open a position at a low implied volatility (IV). For example, when the IV of Nasdaq 100 index options is less than 20%, the premium cost is compressed and the break-even point is easier to reach; when the IV is higher than 40%, it is preferred to use a spread strategy rather than a single-leg buy.

Term matching: Short-term events in the US stock market (such as the Federal Reserve's interest rate meeting) are suitable for contracts expiring within one month, and Bitcoin quarterly contracts are more suitable for macro-cycle layout. During the period of Bitcoin ETF capital inflows in June 2024, the quarterly contract spread strategy has a 22% higher return than the weekly contract because the time loss is more moderate.

Enhanced hedging: Adding spot positions to the spread portfolio can optimize risk-return. For example, while holding 100 shares of Nvidia stock, sell a call option with an exercise price 20% higher than the position cost, and use the premium to buy a call option with a lower exercise price, forming a "spot + spread" dual engine.

In short, the bull market spread is not a prediction tool, but a risk manager. A true expert never regrets that the profit is capped when the market soars, but is glad that the loss is controllable when the market plummets.

Next issue preview:

Tomorrow we will focus on "Bear Market Spread Strategy"

Homework

1. Practical calculation: Assuming the current price of Bitcoin is $63,000, buy a call option with an exercise price of $65,000 (premium $4,500), and sell a call option with an exercise price of $70,000 (premium $1,800). Please calculate: the maximum potential loss amount of the return rate when the net cost and the break-even point currency price rise to $68,000

2. Market observation: Select Bitcoin current month options on the Deribit platform, compare the difference in cost of the spread combination when the strike price deviates from the current price by 5% and 10%, and consider which one is more suitable for the current volatility environment.