Acquired bull spread: Meaning, Criticisms & Real-World Uses

What Is Acquired Bull Spread?

An Acquired Bull Spread is an options trading strategy classified under Options Trading Strategies that aims to profit from a moderate increase in the price of an underlying asset. This strategy involves simultaneously buying a call option at a lower strike price and selling a call option at a higher strike price, both with the same expiration date. The term "acquired" typically refers to the initiation of this spread, where both legs are established at the same time to create a net debit or credit position, depending on the specifics. This particular type of strategy is designed to limit both potential profits and potential losses, making it suitable for investors who anticipate limited upward movement in the underlying asset.

History and Origin

The concept of options trading, the broader financial category to which the Acquired Bull Spread belongs, has roots dating back centuries, with early forms observed in ancient Greece and the Netherlands. However, the modern, standardized exchange-traded options market gained significant traction with the establishment of the Chicago Board Options Exchange (CBOE) in 1973. The CBOE's creation provided a centralized marketplace for trading standardized options contracts, paving the way for the development and widespread adoption of various complex options strategies, including different types of spreads. The standardization of terms and the presence of a clearinghouse facilitated clearer pricing and reduced counterparty risk, making strategies like the Acquired Bull Spread more accessible and understandable for a wider range of investors.

Key Takeaways

The Acquired Bull Spread is a limited-profit, limited-loss derivative strategy.
It involves buying a call at a lower strike price and selling a call at a higher strike price, both with the same expiration.
This strategy is typically implemented when an investor anticipates a moderate upward movement in the underlying asset's price.
The maximum potential profit occurs if the underlying asset's price closes at or above the higher strike price at expiration.
The maximum potential loss is limited to the net premium paid for establishing the spread.

Formula and Calculation

The Acquired Bull Spread involves the calculation of maximum profit, maximum loss, and the breakeven point.

Net Premium Paid:
The cost to establish the spread is the premium paid for the long call minus the premium received from the short call.
[
\text{Net Premium Paid} = \text{Premium (Long Call)} - \text{Premium (Short Call)}
]

Maximum Potential Profit:
The maximum profit for an Acquired Bull Spread is achieved if the underlying asset's price rises above or reaches the higher strike price by expiration.
[
\text{Max Profit} = (\text{Higher Strike Price} - \text{Lower Strike Price}) - \text{Net Premium Paid}
]

Maximum Potential Loss:
The maximum loss for an Acquired Bull Spread occurs if the underlying asset's price falls below or remains at the lower strike price at expiration. In this scenario, both options expire out-of-the-money, and the investor loses the initial net premium paid.
[
\text{Max Loss} = \text{Net Premium Paid}
]

Breakeven Point:
The breakeven point is the price at which the underlying asset must be at expiration for the strategy to neither make a profit nor incur a loss.
[
\text{Breakeven Point} = \text{Lower Strike Price} + \text{Net Premium Paid}
]

Interpreting the Acquired Bull Spread

The Acquired Bull Spread is interpreted as a moderately bullish strategy. Investors use it when they believe the price of the underlying asset will rise, but only to a certain extent. The spread structure provides a defined risk-reward profile, meaning both the potential gain and potential loss are known at the time the trade is initiated. If the asset's price moves significantly higher than the higher strike price, the profit is capped. Conversely, if the price drops below the lower strike, the loss is limited to the initial net premium paid. This characteristic makes it a popular choice for those seeking to capitalize on anticipated moderate price increases without taking on unlimited downside risk, or for those who wish to reduce the cost of a simple long position in a call option.

Hypothetical Example

Consider an investor who believes Stock XYZ, currently trading at $50, will moderately increase in value over the next month. They decide to implement an Acquired Bull Spread.

Buy a call option: The investor buys one XYZ 55-strike call option with one month until expiration date for a premium of $3.00. (Cost: $300 for 100 shares).
Sell a call option: Simultaneously, the investor sells one XYZ 60-strike call option with the same expiration date for a premium of $1.00. (Credit: $100 for 100 shares).

Calculations:

Net Premium Paid = $3.00 (paid) - $1.00 (received) = $2.00 (or $200 for one contract). This is the maximum potential loss.
Breakeven Point = Lower Strike Price + Net Premium Paid = $55 + $2.00 = $57.00.
Maximum Potential Profit = (Higher Strike Price - Lower Strike Price) - Net Premium Paid = ($60 - $55) - $2.00 = $5 - $2.00 = $3.00 (or $300 for one contract).

Outcomes at Expiration:

If XYZ is at $54 (below lower strike): Both options expire worthless. The investor loses the net premium paid of $200.
If XYZ is at $58 (between strikes): The 55-strike call is in-the-money by $3 ($58 - $55), while the 60-strike call is out-of-the-money. The investor exercises the 55-strike call for a gain of $300, but subtracts the initial $200 net premium, resulting in a profit of $100.
If XYZ is at $62 (above higher strike): The 55-strike call is in-the-money by $7, and the 60-strike call is in-the-money by $2. The investor exercises the 55-strike call (worth $700) and is assigned on the 60-strike call (costing $200). The net gain from the options is $500 ($700 - $200). Subtracting the initial $200 net premium, the total profit is $300, which is the maximum profit.

Practical Applications

The Acquired Bull Spread finds several practical applications in investment management and strategic portfolio adjustments. It is commonly employed by investors who hold a moderately bullish view on an underlying asset but want to manage the cost and risk associated with a simple long position in a call option. This strategy allows for more targeted speculation on price movements. For instance, a portfolio manager might use an Acquired Bull Spread to express a short-term positive outlook on a sector while limiting capital at risk, especially in volatile markets. Regulators like FINRA oversee options trading to ensure fair practices and investor protection, establishing rules regarding account approval and risk disclosure, which apply to complex strategies like the Acquired Bull Spread.³ The trading volume of options strategies is substantial, with Cboe reporting billions of options contracts traded annually, demonstrating their widespread use in the financial markets.² This volume reflects how frequently strategies like the Acquired Bull Spread are used for both speculative and risk management purposes.

Limitations and Criticisms

While the Acquired Bull Spread offers defined risk and reward, it comes with limitations. The primary criticism is its capped profit potential. If the underlying asset experiences a significant upward price movement that far exceeds the higher strike price, the investor's profit remains limited to the maximum calculated gain. This can lead to opportunity cost compared to simply holding a long position in the underlying asset or a single call option without the sold leg. Furthermore, the strategy requires careful selection of strike prices and expiration date to align with the investor's outlook. Misjudging the magnitude or timing of the price movement can lead to the maximum loss, even if the general direction was correct. Academic research on options strategies often highlights the importance of appropriate risk management frameworks, emphasizing that even seemingly limited-risk strategies carry inherent complexities and require precise execution to be effective.¹

Acquired Bull Spread vs. Bull Call Spread

The terms Acquired Bull Spread and Bull Call Spread are often used interchangeably to describe the same options strategy. Both refer to the simultaneous purchase of a lower-strike call option and the sale of a higher-strike call option on the same underlying asset with the same expiration date. The "acquired" designation simply emphasizes that both legs of the spread are entered into concurrently, establishing the full spread position from the outset. There is no fundamental difference in their structure or payoff profile. Any confusion typically arises from varying nomenclature used across different brokers or educational resources. Both strategies are designed for a moderately bullish market outlook and share the characteristic of having limited profit and limited loss potential.

FAQs

Q1: What is the primary goal of an Acquired Bull Spread?

The main goal of an Acquired Bull Spread is to profit from a moderate increase in the price of an underlying asset while limiting potential losses.

Q2: What happens if the underlying asset's price falls significantly?

If the underlying asset's price falls below the lower strike price at expiration date, both options contracts in the Acquired Bull Spread typically expire worthless. The investor's maximum loss is limited to the net premium paid when setting up the spread.

Q3: Can an Acquired Bull Spread result in unlimited profit?

No, an Acquired Bull Spread has a capped profit potential. The maximum profit is limited by the difference between the two strike prices minus the net premium paid, regardless of how high the underlying asset's price rises.

Q4: Is an Acquired Bull Spread considered a high-risk strategy?

Compared to buying a naked call option or taking a directional position directly in the underlying asset, an Acquired Bull Spread is generally considered a lower-risk strategy because both potential profit and potential loss are defined at the outset.