Options Trading: Bull Call Spread

basics of technical analysis

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 BULLISHand 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

  1. When you are 60%-70% certain that the market will rise before the expiry date.
  2. When you expect good news over the weekend.
  3. During results period, when you are, say, more than 50% sure of a positive outcome.
  4. #3 can be extended to events as well based on forthcoming corporate meetings.

Caution

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.

 

6 Comments on "Options Trading: Bull Call Spread"

  1. Sir,
    Thanks for sharing this. Was looking to learn options. However I did not understand losing Rs.25 . Could you please explain a bit more? What is did not move as per expectations mean? Can you quote a number here where it moved? Would help

    you will end up losing Rs 25 per unit (135 – 110) X 75 = 1,875

    • sunil.tinani | May 2, 2018 at 2:12 pm | Reply

      You bought the CE at 135 and shorted it at 110. So you pay 135 and receive 110. If the stock does not move as per your expectations, and if it falls, you will have to bear this loss 135-110 = 25.

  2. Tell me how much of money required

  3. Thank you for the explanation.
    My doubt is here:-
    If NIFTY hits 10900 then I make Rs 150 per unit on 10750CE and lose Rs 100 per unit on 10800CE. I paid Rs 135 per unit (10750CE); are you saying that the value per unit has appreciation to Rs ₹ 285? (₹135+₹150)
    Could you please individually explain the impact of Buy CE and Sell CE if NIFTY hits 10900. We would then get 1 positive and 1 negative number. Adding up both these will give us the Net profit/loss.
    Thanks in advance.

    • Example:

      Nifty at 10500

      You buy 10700 CE at 50
      You sell 10800 CE at 30

      Nifty appreciates to 10700

      Now, assume

      10700 CE is 250
      10800 CE at 220

      So you book gain on 10700 CE = 200 (250-50)(you paid 50, sold at 250)
      Then you book loss on buying 1080 CE = 190 (220-30) (you received 30, covered at 220)

      Your net gain is 200-190 = 10

      • Great. Now it is clear. Thank your for the quick response.

        Time when I posted the query should be after 12:00 pm and your response time also should be after that. It is showing 6:13 am and 6:31 am. Need to select the right time zone.

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