A call spread, or bull call spread, is the purchase of a call and the sale of a higher-strike call on the same underlying and expiry. The short call reduces the cost of the position in exchange for capping the gain. Both the maximum gain and the maximum loss are known at inception.
How it works
The buyer pays a net premium equal to the long call price minus the short call price. At expiry, the payoff is zero below the lower strike, rises one for one between the strikes, and is capped at the difference between the strikes above the upper strike. The reverse position, selling the lower strike and buying the upper one, is a bear call spread that collects a credit. A very tight call spread approximates a digital option, which is how desks price and hedge digitals.
Example
Hypothetical three-month options on a stock at 100. A trader buys the 100 call at 4.00 and sells the 110 call at 0.70, a net debit of 3.30. The maximum loss is 3.30 if the stock ends below 100. The maximum gain is 10 − 3.30 = 6.70 at or above 110. Breakeven at expiry is 103.30.
On the desk
On equity indices, the upside strike usually trades at a lower implied volatility than the lower strike. The skew therefore works against the buyer of a call spread, the opposite of a put spread, where the strike sold carries the richer vol. Traders compare the spread price with the flat-vol value to see how much skew they are paying.
Educational definition. Worked examples are hypothetical. Not an offer or a recommendation.