CALL Credit Spread Strategy Characteristics
Maximum Risk: Limited to the difference between the two strike prices of the CALLS minus the net premium received for the position.
Maximum Reward: Limited to the amount of Credit/Premium received at Trade initiation (which is the premium received for the short option minus the premium paid for the long option
When you initiate a CALL CREDIT SPREAD you are Long one CALL option and Short another CALL option with a lower strike price.
You are bullish on Tata Motors which is currently trading at Rs. 248. The February 250 Strike CALL (Expiration Feb 23) is being quoted at an average price of Rs. 7.30 the February 240 Strike CALL (Expiration Feb 23) is being quoted at an average price of Rs. 13.80. To initiate the spread, you will sell the 240 CALL simultaneously buy the 250 CALL for a net credit premium of Rs.6.50 (13.80 – 7.30). The holders of this Credit position are hoping that Tata Motors stays below 250+6.50 or Rs. 243.50 to breakeven or above to profit from the trade by Feb 23rd.
Scenario 1: The stock stays below 240 on Feb 23. Both CALL Options (250 240) expire worthless and you keep the entire premium of Rs. 6.50.
Scenario 2: The stock settles at 251 on Feb 23. The 250 CALL option you bought for Rs. 7.30 is now worth Rs. 1 (251-250) that you have to sell back. The 240 CALL Option you sold at Rs. 13.80 is now worth Rs.11 (251-250) for you to buy back. So you would have to spend Rs. 10 (11-1) to close this position. Since you had taken an initial Credit of Rs. 6.50 at trade initiation, the total loss to you will be Rs. 3.50 (10-6.50).
Scenario 3: The stock settles at 246 on Feb 23. The 240 CALL option you sold for Rs. 13.80 is now worth Rs. 6 (246-240) that you have to buy back. The 250 CALL Option you bought at Rs. 7.30 is now worthless as it is out of money. So you would have to spend Rs. 6 to close this position. Since you had taken a Credit of Rs. 6.50 at trade initiation, the total gain on this position will be Rs. 0.5 (6.5-6).
Take a look at the Payoff Chart for each CALL Credit Spread displayed in the table below.