A bull call spread is a low risk spread that consists of two calls (CEs) that expire on the same date but have different strike prices.
You have to short one call one strike price and buy another call at the at lower strike price.
YOU SHOULD PLAY THIS ONLY WHEN THE TREND IS BULLISH – and you are happy with moderate gains.
How To Play The Bull Call Spread (Example)
Nifty is at 10750 as on 2 May 2018.
Let us assume you are bullish on the market and feel that Nifty can hit 10900 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:
BUY 10750 CE at 135 (1 lot = 75 units)
SELL 10800 CE at 110 (1 lot = 75 units)
If Nifty hits 10900 by 31 May 2018, you will gain Rs 50* X 75 = 3,750 [Less] the square off cost** of Rs 1,875 on your short call (as per the calculation below) = Net gain Rs 1,875
(*You will make Rs 150 per unit on your 10750CE and lose Rs 100 per unit on the 10800CE you sold).
**If Nifty does not move as per your expectations, you will end up losing Rs 25 per unit (135 – 110) X 75 = 1,875.
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.
However, if you are dead certain that the market will move higher, then you can cover the short call and hold on to the long one. But know that if things don’t work out your loss will increase but will be limited to the cost you incurred (135) for the call.
It is however recommended that you close out both options on the same day preferably around the same time. 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.