Monday, 22 April 2013

Bull Call Spread - Bullish Strategy

Bull Call Spread:

Bull Call Spread is an option trading strategy used when option trader is moderately bullish in the market and expects the underlying to give decent returns in near term.

A Bull Call Spread is formed by buying an “In-the-Money Call Option” (lower strike) and selling an “Out-of- the-Money Call Option” (higher strike). Both the call options must have the same underlying security and expiration month.

The net effect of the strategy is to bring down the cost and breakeven on a Buy Call (Long Call) strategy.

The investor will benefit if the underlying Stock/Index rallies. However, the risk is limited on the downside if the underlying Stock/Index makes a correction.

Investor view: Moderately bullish on the Stock/ Index.

Risk: Limited.

Reward: Limited to the net premium paid.

Breakeven: Strike price of Purchased Call + net premium paid.


Bull Call Spread payoff Diagram

Nifty Lot Size
ITM Call Option
Nifty May 5600 Call Purchased @ Rs 122/-
OTM Call Option
Nifty May 5700 Call Sold @ Rs 74/-
Total Premium Paid
Rs 48 (122-74)
Breakeven Point
Strike Price of Purchase Call + Net Premium Paid

Reward Potential

Ø  Maximum Profit = Short Call Strike Price – Strike Price of Purchased call – Net Premium Paid (When both option exercised)
Ø  Profit Achieved When Nifty Settlement Price >= Strike Price of Short Call
Risk Potential
Ø  Maximum Loss = Net Premium paid (When both options unexercised)
Ø  Max Loss, when Nifty Settlement Price <= Strike Price of Purchased call
Nifty Closing Price @
2400   (Loss)
2400   (Loss)
2400   (Loss)
2600   (Profit)
12600 (Profit)

Let us assume Nifty is trading at 5816 in May 2013.An options trader setups a bull call spread by buying a Nifty May 5600 put for Rs 122 and sells  a Nifty 5700 May call for Rs 74. The net debit taken to enter the trade is Rs 2400 ((122-74) X 50 Lot Size)

Scenario 1 :  At Expiry if Nifty dips down to 5500 , both the call option expires out of the money resulting in overall loss of Premium paid of Rs 2400/-

Scenario 2: Let us assume nifty if Trading at 5800 levels , Nifty 5600 Call option would be having an Intrinsic Value of Rs 200 and nifty 5700 Call Option Sold will be having an intrinsic value of Rs 100/- , resulting in Rs 300/- as profit in overall spread but since the option trade has already paid of premium of Rs 48 to enter the trade , Overall Profit if Rs 300-48 = 12600/- (252 X 50 Lot Size)