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 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 Fertilisers and Chemicals is a leading fertilisers company and accounts for nearly 13% of the total Urea produced in the country.
The company posted a year-on-year jump of 22% in total income for Q3FY22.
Even though the quarterly net profit declined for the same period a year ago, the total net profit for the first nine months of FY22 rose nearly 10% for the same period a year ago.
Derivatives build-up
After touching the recent highs of ₹475 last month, the stock corrected to ₹402 recently. It has now bounced back and is trading at ₹410 levels.
The February 430 strike price call option has a significant base suggesting that the stock can face resistance at this price.
This is about 5% higher than the current price of ₹410.
The lot size in the F&O contract is 1,500 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 410 strike price (February expiry) at ₹18 and selling an OTM (out-of-the-money) call option of 430 strike price (February expiry) at ₹10.
Now, if the stocks moves higher and closes at ₹430 levels on expiry, the trader will make a profit of ₹18,000 [Profit on long call option: (2 * 1,500 = 3,000) + profit on short call option: (10 * 1,500 = 15,000)].
However, at the price of ₹430, the profit is capped at ₹18,000 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 position.
The break-even point of this strategy is calculated by adding the ATM (at-the-money) strike price (410) and the net premium paid (18 - 10 = 8). In this case, the break-even point is ₹418 (410 + 8). If the stock closes at ₹418 on expiry, the trader will have neither incurred a profit nor a loss.
If the stock goes down, say below ₹410 levels, the trader's loss is limited to a net premium of ₹12,000 (8 * 1,500).
This strategy has a favourable profit to loss payoff of nearly 1.5:1, which tends to work in 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!