 Hello and welcome to the session. This is Professor Farhad in which we would look at options strategies and specifically we're going to look at spreads. And to be more specific, I'm going to look at a bull spread in this recording. This topic is covered on the CFA exam, essentials of investments, or principles of investment graduate or undergraduate course. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1800 plus accounting, auditing, tax, finance as well as Excel tutorial. Please connect with me on Instagram. If you'd like to like my Facebook page, please do so on my website, farhadlectures.com. You will find additional resources to complement and supplement this course as well other accounting and finance courses. So let's take a look at spreads and options and specifically a bull spread. How does it work? What's a bull spread? Well, a bull spread is a combination of two or more call options or put options. So you're either buying two calls, you're dealing with two calls or two put on the same stock with different either exercise price or different time expiration. So it's the same option. Some options are bought while others are sold. So you buy some, so you buy some calls and you sell some calls the same stock with either a different strike different or the same strike price or a different time expiration. Now what it's, we call it a money spread. When we purchase one option and simultaneously sell another option with a different exercise price. So it's a money spread exercise price. There's another spread called the time spread referred to the sale and the purchase, same thing because the spread is a sale and a purchase of options. Now with differing, with differing expiration, obviously time, expiration, money, price, if you're going to try to remember this for your exams. The best way to illustrate this and to show you the benefit or why would you do something like this? Why would you buy a call and sell a call at the same time? And specifically, we're going to be working a money spread. So let's take a look at this. Let's assume we're going to buy a September 40 call for $3. The reason I put negative three to kind of remind you I'm paying $3 for that option and it's September and the strike price is 40. Let's take a look at this call separately. How does this call work? Well, let's graph it and hopefully we know how to do this graph now. So this is the vertical line for the profit and loss. This is the stock price. So this is the profit loss. This is the stock price. The strike price for us is 40 and we paid $3 to buy this call. And what's going to happen is this, as long as the price is below 40, we don't really benefit. We paid $3. We don't really benefit. Once it reaches 40, it started to rise and it's going to hit the break even point obviously at 43. Obviously, I see obviously because I paid $3. So basically, my break even becomes 43 and once it goes above 43 to 44, 45 for every dollar above 43, I make a dollar and profit. Okay. And my profit could go unlimited. It could go up to $10,000. And guess what? I can buy it at 40, but really my true basis is 43, which is my break even point because I have the right to buy it at 40, but I paid $3. Therefore, my cost basis is 43. So when up to 50, if it goes up to 50, I'll make $7 of profit. So that's basically the regular, basically this is a call, one call. Now here's what I'm going to do. I'm going to buy this call, okay, buy this September 40 call. At the same time, I'm going to sell a September 45 call for a dollar. No, I'm selling the call for a dollar. Why would I do that? Well, we'll explain why. So notice what's going to happen. I buy one, I sell one, now my net cost is $2 for this combination. Now what would the graph looks like when I have both of these together? So this is what it looks like. Again, this is the profit and loss line. This is the stock price. And now my net cost is negative $2. The strike price is 40. Now my break even is 42. So that's going to look something like this. Anything below 40, basically my net cost is useless. When this reaches 40, it's going to go up and it's going to hit the zero profit line. This is the zero profit line. It's going to hit the zero profit line at 42. So the first thing I want you to notice, my break even now is my break even is 42 because my net cost is 2 and I can buy it at 40. 40 plus 2 equal to 42. And what's going to happen starting from 42. Again, I'm going to make profit. But remember, I sold a call for 45. So once the stock price reaches 45, I sold the call. It means now I have to deliver the stock or my options start to lose money. What's going to happen is this. My profit at 45 will flattened. Why? Because even if I make more profit on this option, if I make $1 additional dollar profit, I'm going to lose one additional dollar on selling the call. So basically my profit will flattened out. Let me do it again. It goes up until it reaches 45, then it flattens. So what happened is this. Simply put what happened is this. I can make a profit. The best way for me is for the stock price to go up to 45 and stop. So it's useless for this person. The option is useless for this person. I can buy it at 40. I pay 2 extra dollar. My basis is 42. Then I can make $3 profit. So the max I can make in profit in this is $3. If it goes up to 45, again, if it goes up to 45 exactly and it stops, I will make $3. This is the max profit I can make because I can buy my cost basis is 42. My break even is 42 and sell it at 45. And the other person, if it doesn't exceed 45, they are not going to call it. They're not going to. They're not going to call it. In other words, I don't have to deliver anything and the option will not lose any money because 45 is the exercise price. It has to be above 40 for me to start lose money on my option. So notice the max. I can max make a max profit of $3. That's the max profit versus here. The profit is unlimited. So you might be saying, why would I, why would I do something like this? Why would you do something like this? Unless you think, if you think, if you think this stock, it's going to skyrocket. If this stock is going to skyrocket, like you remember when we talked about the straddle, we said you think the stock price, it's either going to skyrocket or the stock price is going to go down substantially. If that's the case, you don't use a spread. You would use a straddle. But here what you are saying, you are saying the stock price might go up a little bit, but not too much. So what you would do is you would say, if it goes up a little bit, I will make money on my call. And the other person, because the strike price is higher, they may not be able to take advantage of it. Therefore, by doing so, I reduced my basis from $43 to $42. I reduced my basis by $1. So now, but I limit my profit. Again, when do you do so? When you think the stock price is not going to skyrocket. It's going to stay within that limit. Therefore, you will buy it. You will make a little bit of profit. And by selling the call, you reduced your cost, which is you make a little bit of additional profit. So that's the goal of a bull spread. And this is a bull because you are bullish. It's going to go up a little. We also have a bearish spread. And we'll talk about the bearish spread in a different recording. Again, hopefully you got the gist of it, the big picture. Later on, I will work an exercise or two combining all these strategies so things will make more sense. As always, I'm going to remind you to like this recording, share it and check out my website, farhatlectures.com for additional resources. It might help you navigate this course a little bit better.