Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative bull call spread strategy requires the investor to buy deep-in-the-money call options instead.

Since the objective of writing covered calls is to earn premiums, it makes sense to sell near-month options as time decay is at its greatest for these options.  Hence, the two strategies that we are comparing will involve selling near-month slightly out-of-the-money call options.  

Comparison of Profit Graphs for Bull Call Spread & Covered Call Write


Suppose we have a stock XYZ currently trading at $50 in June and the JUL 55 call is priced at $2 while a JUL 45 call is priced at $5.50.

Investor A enters a bull call spread by buying the JUL 45 call while selling the JUL 55 call. His upfront investment is $550 (long call) - $200 (short call) = $350. 

Investor B does a covered write by buying 100 shares of XYZ at $50 each and selling a JUL 55 call. His upfront investment is $5000 (long stock) - $200 (short call) = $4800. 

The table below shows their profit/loss at various stock price on expiration date.

Strategy Upfront Investment Stock Price on Expiration Date
Below $45 $45 $50 $55 & Above
Bull Call Spread $350 -$350 -$350 +$150 +$650
Covered Call $4800 Unlimited -$300 +$200 +$700

As can be seen, the maximum potential profit for the bull call spread is only slightly lesser than the covered call but the covered call has a potentially unlimited downside risk (all the way up to $4800 in potential losses).

Hence, the bull call spread is clearly a superior strategy to the covered call if the investor is willing to sacrifice some profits in return for higher leverage and significantly greater downside protection.

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