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
Aditya Birla Capital Limited (ABCL) is the holding company for the financial services businesses of the Aditya Birla Group and its subsidiaries have a strong presence across Protecting, Investing and Financing solutions.
Recently, the stock has given a cross its short-term moving day averages (15 days and 50 days) from below suggesting short-term positive momentum in the stock.
Derivatives build-up
After touching the recent highs of ₹139 last week, the stock corrected to ₹132 in the market fall. It has now bounced back and is trading at ₹135 levels.
The January 140 strike price call option has a significant base suggesting that the stock can face resistance at this price.
This is about 4% higher than the current price of ₹135.
The lot size in the F&O contract is 4,400 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 135 strike price (January expiry) at ₹5.25 and selling an OTM (out-of-the-money) call option of 140 strike price (January expiry) at ₹3.25.
Now, if the stocks moves higher and closes at ₹140 levels on expiry, the trader will make a profit of ₹13,200 [Loss on long call option: (0.25 * 4,400 = 1,100) + profit on short call option: (3.25 * 4,400 = 14,300)].
However, at the price of ₹140, the profit is capped at ₹13,200 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 (135) and the net premium paid (5.25 - 3.25 = 2). In this case, the break-even point is ₹137 (135 + 2). If the stock closes at ₹137 on expiry, the trader will have neither incurred a profit nor a loss.
In case the stock goes down, say below ₹135 levels, the trader's loss is limited to a net premium paid of ₹8,800 (2 * 4,400).
This strategy has a favorable profit to loss payoff of nearly 1.5:1, which tends to work in the favor 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!