The Hindu Business Line : Bullish? Set a bull call spread

We suggest traders to set this spread using option strikes of 2900 and 3200; that is to say, buy Nifty 2900 call, which closed the week at Rs 218 and sell Nifty 3200 call, which closed at Rs 89. Note that this will entail an initial cash outflow of Rs 129 per share (or a total of Rs 6,468 for per lot).

While ideally both the legs of this strategy should be executed simultaneously so as to benefit from the lower cost of setting the spread (as the premium inflow from selling the options, to an extent, will compensate for the premium to be paid for buying the other option), you can time the purchase and sale of options depending on how the markets open on Monday.

For instance, if the market opens with a gap up, you can consider selling the call first as that would then fetch a higher price.

Buying the lower strike call can be reserved for the time when market begins to show signs of cooling off. A reverse of this can be considered if markets open lower. That said, it is imperative that execute both the legs of this option spread on the same day.

Why a bull call spread?

Bull Call spreads should be considered when you are moderately bullish on the underlying. Nifty currently appears set to trend upwards if we take into consideration the sharp reversal seen in the bellwether last week.

That the RBI has also cut interest rates may also play favourably on Nifty. While traders can consider buying plain call options on Nifty, we feel it a safer bet to stick to limited risk-return strategies such as bull call spreads for the week.

Risk-return tradeoffs

Depending on how Nifty moves, this strategy will deliver returns within a range.

The breakeven for this spread would be at 3029 (2900 +129), i.e. strike price of the purchased call plus the net debit paid for setting the spread.

That is if Nifty moves past 3029, your spread will turn in the money.

However, note that the maximum loss that can occur in any scenario will be limited to the cost of setting this spread (in this case Rs 6,468).

If Nifty closes above 3200 (say at 3300), while your 2900 call will deliver a profit of Rs 400 (3300-2900), the sold call at 3200 strike will result in a loss of Rs 100 (3300-3200). So the net profit will be Rs [(400-100) minus the cost of setting the spread].

That is the maximum profit will be limited to Rs 171 per share. So, for an initial outlay of Rs 129 per share, you will stand to gain Rs 171 per share, if Nifty moves up.

If Nifty were to close at 3100, then you will make a profit of Rs 200 on the 2900 call (purchased) and no profit on the 3200 call that was sold.

So, the net profit would be Rs 200 minus the initial cost of setting the spread.

On the contrary, if Nifty were to close at any price below the 2900, the strike price of the purchased option, then you will lose the money that was used to set this spread.

But since it is a limited return strategy, traders can consider closing the spread once Nifty moves past the strike of the sold option.

Similarly, if in the interim period Nifty starts to show signs of weakness, traders can consider a premature exit from the spread. — Srividhya Sivakumar

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