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
In the December quarter, the housing finance company Can Fin Homes' net sales jumped 1.1% year-on-year to ₹508.27 crore. However, the company's net profit declined 12% to ₹116 crore. The sharp fall in the bottom line was due to a 2% decline in its net interest income which stood at ₹206 crore.
Derivatives build-up
From its February high of ₹670, the stock fell to ₹520 levels. The April expiry 700 strike price call option has a significant base suggesting that the stock may face resistance at this price. This is about 5% higher than the current price of ₹668.
The lot size in the F&O contract is 975 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 670 strike price (April expiry) at ₹30 and selling an OTM (out-of-the-money) call option of 700 strike price (April expiry) at ₹18.
Now, if the stock moves higher and closes around ₹700 on expiry, the trader will make a profit of ₹17,550 [Profit on long call option: (₹0 * 975 = ₹0) + profit on short call option: (₹18 * 975 = ₹17,550)].
However, at the price of ₹700, the profit is capped at ₹17,550 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 (670) and the net premium paid (₹30 - ₹18 = ₹12). In this case, the break-even point is ₹682 (670 + 12). Even if the stock closes at ₹682 on expiry, the trader will have neither incurred a profit nor a loss.
In case the stock falls and closes lower at expiry, say below ₹670, the trader's loss is limited to the net premium paid of ₹11,700 (₹12 * 975).
This strategy has a favourable profit to loss payoff of nearly 1.5:1, 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.