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
Mumbai based realtor Oberoi Realty reported a 63% increase in its consolidated net profit at ₹467 crore for the quarter ended December. The company's net sales remained flat at ₹832 crore in Q3 FY22 over Q3FY21.
The management said that the real estate sector has witnessed a strong sales momentum due to supply-side consolidation and a shift in consumer preference towards established players. In the commercial segment, the company said that leasing activity is gradually picking up, and with the pandemic easing out, the retail business is also set to make a comeback.
Derivatives build-up
The stock recently crossed its January month high of ₹997 and has risen further from the low of ₹786.
The 1,000 strike price call option of March series has a significant base suggesting that the stock can face resistance at this price.
This is about 6% higher than the current price of ₹943.
The lot size in the F&O contract is 700 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 940 strike price (March expiry) at ₹20 and selling an OTM (out-of-the-money) call option of 1,000 strike price (March expiry) at ₹6.
Now, if the stocks moves higher and closes at ₹1,000 levels on expiry, the trader will make a profit of ₹32,200 [Profit on long call option: (₹40 * 700 = ₹28,000) + profit on short call option: (₹6 * 700 = ₹4,200)].
However, at the price of ₹1,000, the profit is capped at ₹32,200 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 (940) and the net premium paid (₹20 - ₹6 = ₹14). In this case, the break-even point is ₹954 (940 + 14). If the stock closes at ₹954 on expiry, the trader will have neither incurred a profit nor a loss.
In case the stock goes down, say below ₹940 levels, the trader's loss is limited to a net premium paid of ₹9,800 (₹14 * 700).
This strategy has a favourable profit to loss payoff of nearly 3:1, 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.