A bull put spread is a low risk, low gain spread that entails trading in two puts (PEs) that expire on the same date but at different strike prices.
You have to short one put option and buy another put at a lower strike price. The put you short generates the income and the put you buy minimizes your loss, if any.
YOU SHOULD PLAY THIS ONLY WHEN THE TREND IS BULLISH.
How To Play The Bull Put Spread (Example)
Nifty is at 10650 as on 3 May 2018.
Let us assume you are bullish on the market and feel that Nifty can hit 10800 by end-May. But knowing that markets are uncertain, you would not like to buy a naked (one side) option.
So here’s what you can do:
SELL 10600 PE at 105 (1 lot = 75 units)
BUY 10500 PE at 75 (1 lot = 75 units)
If Nifty hits 10,800 by 31 May 2018, both PEs will not be exercised, and you will gain
Rs 30* X 75 = 2,250
(*You will receive 105 and pay 75).
If Nifty does not move as per your expectations, and it falls, both options will get exercised and in the worst case and your loss will be limited to your hedge (shorted at 105, covered at 75, therefore loss is RS 30):
Rs 30 per unit (the difference ) X 75 = 2,250 maximum.
If the strategy does not work out and the Nifty declines, it is not necessary that you will have to incur the entire loss. In order to limit the loss you must read the fall well and cover the short option and wait for the long put option to appreciate. Know that if your calculation does not work out your loss will increase but will be limited to the cost you incurred (75 per unit) for the put.
Either way your gains and losses are capped.
You should enter into this trade only when the prices are steady or in a bull trend. This strategy is ideal for folks who are averse to risk-taking and are content with small profits (or losses).
When To Play The Bull Call Spread
- When you are 60%-70% certain that the market will rise before the expiry date.
- When you expect good news over the weekend.
- During results period, when you are, say, more than 50% sure of a positive outcome.
- #3 can be extended to events as well based on forthcoming corporate meetings.
Square up both the calls at the same time. It is extremely dangerous to leave a short call open in a volatile market.
It is however recommended that you close out both options on the same day preferably around the same time.
AGAIN: Never leave a short option open – if markets turn, you will end up paying through your nose.
Remember that as time passes and the expiration comes closer, the time value of options erode rapidly. Therefore you must book your profits or losses ahead of expiry.
If you are new to options, create an Excel sheet and enter into mock trades. Play the real market only when you have sort of mastered options.
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