A bull call spread strategy is an option strategy that traders implement when they are “moderately” bullish on a stock or an index. In this strategy, traders buy ATM (at-the-money) call option and sell OTM (out-of-the-money) call option to reduce their cost.
Let’s see how this strategy works.
Background
Tata Power is a leading power generation company in the country and has the distinction of being among the top private players in each sector of the value chain including solar rooftop and value-added services.
Recently, the company won utility scale EPC orders of 1,000 MW worth nearly ₹3,000 crore.
The company’s credit rating was also upgraded two notches to BB (Stable) by S&P Global Ratings.
Derivatives build-up
After touching the recent highs of ₹268 levels, the stock corrected to ₹201 levels in the market fall. It has now bounced back and is trading at ₹231 levels.
The November 250 strike price call option has a significant base, suggesting that the stock can face resistance at this price.
This is about 8% higher than the current price of ₹231.
The lot size in the F&O contract is 6,750 shares per lot.
Action
Traders willing to take a moderately bullish position on it tend to initiate a bull call spread strategy that involves buying an ATM (At-the-money) call option of 230 strike price (November expiry) at ₹14 and selling OTM (out-of-the-money) call options of 250 strike price (November expiry) at ₹8.
Now, if the stocks moves higher and closes at ₹250 levels on expiry, the trader will make a profit of ₹94,500 (Profit on Long Call: (6*6,750 = ₹40,500) + Profit on Short Call Options: (8*6,750 = ₹54,000)).
However, at the price of ₹250, the profit is capped at ₹94,500 because above this rate every one rupee increase in premium of the long call position will be offset by a one rupee increase in premium of the short call option position.
The break-even point of this strategy is calculated by adding the ATM (at-the-money) strike price (230) and the net premium paid (14 - 8 = 6) , which in this case is ₹236 (230 + 6). If the stock closes at ₹236 on expiry, the trader will made neither a profit nor a loss.
In case the stock goes down, say below ₹230 levels, the trader's loss is limited to a net premium paid of ₹40,500 (6*6,750).
This strategy has a favourable profit to loss payoff of more than 2:1, 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 continue bring you a lot of strategies that will help you to identify trade setups easily.
Until then, happy trading!