An options strategy used by life insurance companies that sell indexed universal life insurance. The insurance company initiates an index call spread by buying a call option at a particular strike price while simultaneously selling (shorting) a call option at a higher strike price. Both options typically have the same expiration date.
The options are usually purchased and sold on the S&P 500, but other indices could be used, like the NASDAQ, DOW Jones, or Russel 2000.
If the price of the underlying index rises above the break-even price for the options, the gain is credited to the policyholder’s policy. Any losses are absorbed by the insurance company.
Call spreads work by limiting upside potential gain as well as limiting losses. The issuing insurance company never profits from the options contracts themselves. Instead, the company makes all its profits from policy charges and any excess interest on its bonds not used to buy the options.
The net result of this strategy is that policyholders can expect some upside potential in their indexed universal life policy with downside protection.
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