What are call spreads: trade directionally while managing risk

Keen to gain long exposure to a specific coin or token but want to keep your risk low? Multi-leg crypto option strategies like call spreads could be right up your alley. By tacking on an extra option leg, you can maintain the same amount of exposure while limiting your maximum potential loss.

Interested in learning more about call spreads and how they may suit both bullish and bearish scenarios? In this guide to call spreads, we introduce the strategy and explain how it can be lucrative in different scenarios. We'll then discuss its advantages, and the situations in which a crypto options trader might look to deploy either a long or short call spread. After addressing the strategy’s risks, we'll conclude with a possible call spread trading plan to execute.

TL;DR

• Call spreads are multi-leg option strategies that involve buying and selling call options with different strike prices on the same underlying asset.

• The benefit of trading call spreads is that they offer aspects of risk mitigation on top of gains compared to outright spot or futures positions.

• The maximum loss for call spreads is known upfront and is limited to the difference between the strike prices.

• Key factors to consider when trading call spreads include time to expiration, implied volatility, and liquidity. The risks include limited potential for gains and execution risk.

• A trading plan involving call spread should take into account careful analysis of the underlying asset, choosing appropriate strike prices, and managing risk over time.

What is a call spread?

A call spread is a multi-leg options trading strategy that involves buying and selling two differently priced options contracts with the same underlying asset and expiration date at the same time. When buying a call spread, the trader will buy a call with a lower strike price and sell one with a higher strike price. On the other hand, when selling a call spread, the trader will sell a lower strike call and buy one with a higher strike. Such vertical call spreads seek to lock in gains based on the expected price moves to the upside or downside while significantly limiting risk compared to simply longing or shorting the underlying spot crypto asset.

Not to be confused with a call calendar spread, a call spread is a limited risk and directional crypto options trading strategy that involves simultaneously buying and selling call options contracts. Crucially, each leg should share the same underlying asset and expiry date but have a different strike price.

Call spread characteristics

Keen to learn how call spreads stand out from other multi-leg crypto option strategies? The key characteristics of a call spread are as follows.

• Must be a call option strategy comprising of two legs.

• Each call must be for the same underlying asset with the same expiry date.

• Option legs must be directionally opposite of each other.

• Call legs should have different strike prices.

• The quantity of the underlying traded in each leg must be identical, so the number of long calls offset the number of short calls.

Bull call spreads vs bear call spreads

There are two types of vertical call spreads. A bull call spread (or long call spread) involves buying an in-the-money (ITM) contract and selling an out-of-the-money (OTM) call contract. Conversely, a bear call spread (or short call spread) involves selling an ITM strike price contract and buying an OTM call.

Buying a call spread is another name for deploying a bull call spread. A trader will look to buy a call for lower than the underlying asset's current market price and sell one above it. The inverse is true when selling the spread. As the names suggest, a trader deploying a bull call spread anticipates the underlying asset’s price to rise, and a bear call spread seeks to gain from a price decline.

When entering a bull or bear call spread, a trader pays to buy a call and receives payment for selling a call. This difference is known as the trade’s 'debit' if it loses the trader's capital, and 'credit' if it returns capital.

Explaining gains, losses, and breakeven points for bull and bear call spreads

Gains

A trader enjoys maximum gains from a bull call spread when the underlying asset’s price rises above the higher strike price. In this case, both long and short call options are considered ITM and can be exercised upon expiry. The difference between the two strike prices represents the net gains made from the bull call spread after subtracting the premiums paid to enter the trade.

A trader reaps maximum gains from a bear call spread when the underlying asset’s price falls below both call’s strike prices. In this scenario, both options are OTM and expire worthless, meaning there's no further action needed. However, the trader selling the call spread will have reaped some gains from the credit received when entering the bear call spread trade.

Losses

A bull call spread’s maximum possible loss is incurred when the spot price is below both call options’ strike prices at the time of the calls' expiry. With both options expiring OTM, the trader’s loss is limited to the debit paid to execute the bull call spread.

Meanwhile, the maximum loss of a bear call spread is incurred when the spot price rises above both calls’ strike prices. In this scenario, both options are considered ITM and exercised. Thankfully, the losses are limited to the spread width of both call options. These losses are further subsidized by the credit the crypto options trader received when executing the bear call spread.

Breakeven points

The breakeven point of a bull call spread is calculated by adding the debited premium to the lower strike price. Any price above this point at expiry will result in gains. Meanwhile, a bear call spread’s breakeven point is calculated by subtracting the credit from the upper strike price. Any price below this point at expiry will result in gains.

Why trade call spreads? Highlighting call spread benefits

When trading either a bear or bull call spread, losses, gains, and a trade’s breakeven point are all known in advance. The strategy still allows a trader to speculate on the underlying asset’s price direction, but with much less risk than simply taking an outright spot or futures position on the asset.

A bull call spread enables a trader to bet on future price increases while ensuring that losses incurred from a sudden price drop are limited. Similarly, a bear call spread allows a trader to speculate on an underlying’s price decline without the infinite loss risks that selling naked single-leg call options carry.

Call spreads are also more cost-effective than simply taking either a long or short options position. By taking both sides of a trade, the funds received for the short leg offset those spent on the long leg. If the trader had bought only a call option, their total cost would certainly be greater.

Lastly, executing a call spread is considered capital-efficient because it provides a more attractive margin requirement than trading directionally with single options contracts. With opposite positions open simultaneously, one position offsets the other trade leg. Therefore, margin requirements will be limited to the difference between the two options’ strike prices.

Risks of trading call spreads

While traders use both bull and bear call spreads to mitigate risk, the strategy does have some downsides. Its main drawback is that it has limited potential for gains. If the underlying asset rallies above the upper strike price when deploying a bull call spread, the trader will miss out on much of the upside. Similarly, if the underlying plunges with a short call spread, there’s no value in keeping the positions open below the lower strike price.

As with any multi-leg trading strategy, execution risk is also a factor. If only one leg fills, the trader is suddenly exposed to the risks the call spread was supposed to mitigate. If only the long leg fills, they don’t benefit from the short leg offsetting the cost of the trade. If only the short leg fills, they’re exposed to potentially infinite losses. If the underlying asset suddenly rallies, which it can do at a moment’s notice in the volatile crypto markets, losses from selling a naked call like this can be extreme.

Call spread example

Let’s look at the following ETH options example to illustrate how call spreads work when it comes to planning and executing them.

Source: TradingView

For this example, ETH is trading at $2,648 and we're taking a look at Ether prices on a weekly timeframe. Based on the Fibonacci retracement tool, we can see that ETH prices seem to be trading in a range between the 0.236 and 0.382 retracement lines. By treating these as support and resistance lines, we can execute a potential bull call spread option strategy. The MACD indicator further reinforces ETH's bullish momentum as we can see it curling upwards and potentially cross above the zero line.

To execute a medium risk bull call spread, we can consider calls with a longer time to expiry and less aggressive strike price targets. In this case, let's consider ETH calls that are expiring November 8, 2024 and calls with strike prices of $2,600 and $3,400. This gives a net debit premium of about $209 as we subtract the short call option premium of 0.019 ETH from the long call option premium of 0.098 ETH.

To summarize, we'll be paying $209 for a bull call spread with strike prices between $2,600 and $3,400 that'll expire on November 8, 2024. This $209 represents the maximum loss we might face should both calls expire OTM. Gains wise, the maximum that we'll get to enjoy is $591 should ETH prices exceed $3,400 at the time of option expiry. This gives a risk-reward ratio of about 35%, since you'll be risking $209 for a potential maximum reward of $509.

Final words and next steps

Trading call spread options strategies is a popular way to trade directionally in a market while avoiding exposure to a volatile asset moving against a position. While their upside potential is limited, careful monitoring of positions ensures relatively medium risk gains when a trader correctly anticipates a crypto asset’s future price trajectory. This ultimately ensures a healthy balance of risk-reward as you navigate through the volatility of the crypto market.

Keen to learn more about trading crypto options with us? Check out our guides to options trading basics like implied volatility. For more advanced options guides, read our take on crypto options hedging and put call parity arbitrage strategies.