When to use it?
A rise seen as likely but limited. The short call funds part of the purchase: the breakeven sits lower than on a plain call, and the maximum loss is known up front.
When to avoid it?
A violent upside move: the gain is capped at the second strike, and everything beyond it is given up. Two legs also mean two bid-ask spreads to cross, on the way in and on the way out.
How it works
Two legs, same expiry:
• BUY a call at the lower strike — this is the leg that carries the upside.
• SELL a call at the higher strike — the premium collected reduces the outlay.
The net cost is the difference between the two premiums (a debit). It is also the maximum loss.
At expiry:
• Below the lower strike: both calls expire worthless. Loss = net debit.
• Between the two: the long call has value, the short one does not. The gain rises linearly.
• Above the higher strike: both have value and their difference is fixed. The gain stops moving.
Concrete example
Stock at $100. Buy the 100 call at $5, sell the 110 call at $2.
Net debit: $3 × 100 = $300.
• Stock at $95 → both expire worthless. Loss = $300.
• Stock at $103 → breakeven (100 + 3). P&L = 0.
• Stock at $107 → gain = (7 − 3) × 100 = $400.
• Stock at $110 → maximum gain = (10 − 3) × 100 = $700.
• Stock at $200 → still $700. The extra $90 of upside goes to whoever bought the call you sold.
Ratio: $300 at risk for $700 at best, with a breakeven $3 lower than on a plain call.
What the diagram does not show
The SHORT call can be assigned before expiry, especially the day before an ex-dividend date on an American option. Assignment delivers 100 short shares, and the bounded spread suddenly becomes a short position in the stock — with the margin call that comes with it.
A second thing the diagram hides: it shows expiry. Before then, the position rarely matches the curve, because the two legs do not shed their time value at the same pace.
Options are high-risk derivative products. Losses can exceed the capital initially committed (particularly for uncovered short positions). Polaris provides educational content only — this is not investment advice. Consult a registered advisor (AMF) before any decision and make sure you have the appropriate level of approval from your broker.