A bull call spread strategy is an options strategy that traders implement when they are “moderately” bullish on a stock or an index. In this strategy, traders buy an ATM (at-the-money) call option and sell an OTM (out-of-the-money) call option to reduce their cost. Let’s see how this strategy works.
Background
Chambal Fertiliser's net profit declined 8% to ₹435 crore in Q3 of FY22 from 470 crore during the same period last year. However, the company's total income increased more than 22% to ₹4,743 crore.
In the recent market fall, the stock took support at its 200 DMA and has risen more than 35% from its lows.
Derivatives build-up
From its January high, the stock fell to ₹349 and has bounced back to ₹468 levels. The April expiry's 500 strike price call option has a significant base suggesting that the stock can face resistance at this price which is nearly 7% higher than the current price of ₹468.
The lot size in the F&O contract is 1500 shares per lot.
Action
From the January highs of ₹485,the stock fell to ₹349 levels and has bounced back to ₹468 levels
The April 500 strike price call option has a significant base suggesting that the stock can face resistance at this price.
This is about 7% higher than the current price of ₹468.
The lot size in the F&O contract is 1,500 shares per lot.
Action
Traders willing to take a moderately bullish position on the stock tend to initiate a bull call spread strategy that involves buying an ATM (at-the-money) call option of 470 strike price (April expiry) at ₹23 and selling an OTM (out-of-the-money) call option of 500 strike price (April expiry) at ₹12.
Now, if the stocks moves higher and closes around₹500 on expiry, the trader will make a profit of ₹28,500 [Profit on long call option: (₹7 * 1,500 = ₹10,500) + profit on short call option: (₹12 * 1,500 = ₹18,000)].
However, at the price of ₹500, the profit is capped at ₹28,500 because above this rate, every one rupee increase in the premium of the long call position will be offset by a one rupee increase in the premium of the short call position.
The break-even point of this strategy is calculated by adding the ATM (at-the-money) strike price (470) and the net premium paid (₹23 - ₹12 = ₹11). In this case, the break-even point is ₹481 (480 + 11). If the stock closes at ₹481 on expiry, the trader will have neither incurred a profit nor a loss.
In case the stock goes down, say below ₹470 levels, the trader's loss is limited to a net premium paid of ₹16,500 (₹11 * 1,500).
This strategy has a favourable profit to loss payoff of nearly 1.7:1, which tends to work in the favour of the trader.
We hope this strategy was simple and easy to understand. You can try spotting it on the option chain and see if you are able to identify levels.
We’ll bring you a lot of strategies that will help you to identify trade setups easily.
Until then, happy trading!
About the author: Kush Bohra is a SEBI-registered investment advisor and an F&O expert.
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Disclaimer Derivatives trading must be done only by traders who fully understand the risks associated with them and strictly apply risk mechanisms like stop-losses. We do not recommend any particular stock. The stock names mentioned in this article are purely for showing how to do analysis. Take your own decision before investing.
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