From a winning long call to a bull vertical debit spread

A winning long call is still unfinished

A long call that has already gained after an underlying advance can be converted into a bull call spread by selling a higher-strike call against the existing long call. That completed pair is an option spread: a long option and a short option handled as one position so entry, exit, and expiration abstention can be judged as a single procedure.

A bull call spread is the call form of that vertical: keep the original lower-strike call and sell a higher-strike call after the underlying has already advanced.

Selling a higher strike completes the vertical

In the supplied case, a 50-strike call bought for 2.50 is later paired with a 57.50 call sold for 3.00 after the underlying moves from 50 to 55, leaving a 0.50 net credit on the completed vertical.

Selling that higher strike is an adjustment, a change to an open option that recasts remaining risk and remaining reward instead of simply closing the trade. The resulting structure matches a vertical debit spread: a same-class, same-expiration book that is long a nearer strike and short a farther strike, usually for a net debit, so remaining loss and remaining gain are both bounded.

Expiration paths and the hard cap

If the underlying is then below 50 at expiration, both calls can expire unexercised and the remaining result is that 0.50 net credit.

If the underlying is above 57.50 at expiration, the short 57.50 call can be assigned and the long 50 call exercised, buying at 50 and selling at 57.50. Assignment is the short-call obligation to sell the underlying at the short strike if that call finishes in the money. The spread can also be closed before expiration to avoid assignment.

The completed vertical can still earn more if the underlying continues higher, but remaining upside stops at the short strike, and the choice of adjustment depends on the remaining price view and risk tolerance.

Smaller vehicles and the listed market

A large cash-settled index near 1,300 can carry expensive at-the-money premiums, described as sometimes 2,000 to 3,000 for a contract with about one month of life, which is why a one-tenth mini index and a one-tenth exchange-traded fund exist as smaller vehicles. A mini index is a reduced-notional index scaled as a fraction of a large parent index so option premiums are smaller.

When that parent index is near 1,300, both the mini index and the share-traded fund sit near 130. The fund can be traded in shares and its options settle into shares, while the full and mini indexes settle in cash. Cash-settlement is index-style expiration that pays or receives cash rather than delivering shares. Share-settlement is equity-style expiration in which in-the-money options convert into stock rather than cash.

The listed-options market described for this period already had six US exchanges making markets in equity and index options, with two venues handling about two-thirds of volume and a seventh venue expected in 2007.