Bullish traders are the ones who have positive view on the markets or an underlying security for the coming days.
They expect prices of these securities to move higher .The aim of traders is to utilise this up move to make money by trading Options.
You can use various option trading strategies to play the bullish trades.Some are simple while others are combination of them.
Let’s talk about these strategies ;
Buy Call Option – When the price of underlying security increases, the price of call options for that security also increase.
To make the best out of a price up move, you may simply buy a call option. The amount paid to buy an option is called as Option Premium.
See the above image to understand it better.
A stock TCS is trading at market price of ₹ 2584.80. Suppose, you expect it to move to 2650 in next 3-4 days.
You may buy 2600 Strike call option which is costing ₹ 37 per lot. The option premium you pay to buy this call option is 125 X 37 = ₹ 4625.
When the stock moves to 2650 after 4 days, the option price shall be ₹ 65. Now the value of your capital is 125 X 65 = ₹ 8125. Thus you made a profit of 65 – 37 = 28 X 125 = ₹ 3500 or 8125 – 4625 = ₹ 3500 on your traded capital of ₹ 4626 (75% return).
When you buy options, you have limited risk and unlimited profit potential.
Sell Put Option (Put Writing) – When the price of underlying security increases, the price of put options for that security decreases. So you first sell a put option at higher price and buy back at lower price.
The difference between your selling and buying price is your net profit.
Take example with same stock, TCS with put options. You may choose to sell 2600 strike put option, trading at ₹ 47.80.
While selling options, you get option premium as your profit while investing a margin amount to create a trade.
When the stock moves to ₹ 2650 in next 4 days, the put option price drops to ₹ 13. Closing your trading position at ₹ 13, you make a profit of 47.80 – 13 = 34.8 X 125 = ₹ 4350.
The reason for higher profit than buying call option is because of time decay in option price which works in favour of option sellers or option writers.
Selling Options yield limited profits with unlimited risk potential.
Bull Call Spread – Bull call spreads are created by simultaneously buying and selling different strike call options for the same underlying in same month contract.
You buy a lower strike call option and sell a higher strike call option.
Buying call option costs you the option premium while you get option premium when you sell call option. Lower strike calls are costly while higher strike calls are cheaper. Thus, your investment cost is decreased when you create a bull call spread.
Bull call spreads keep you partially exposed to the market moves. The strategy is aimed to keep the risks limited. Consequently, the profit potential is also limited.
Look at the upper first image to understand this.
We want to create Bull Call Spread for TCS trading at 2584. We may choose any two options depending upon the price up move expected.
Suppose, we want to go with 2600 and 2650 strike options.
We may buy 2600 strike call option at price of ₹ 37 which costs us 125 X 37 = ₹ 4625. Next we sell 2650 strike call option at price of ₹ 19 (assume 19 in stead of 19.55).
Selling it would give us 125 X 19 = 2375. So, our net cost or net option premium paid to create the strategy comes out 37 – 19 = 18 X 125 = ₹ 2250 or 4625 – 2375 = ₹ 2250.
Now, if the stock starts moving up, 2600 call shall start making money while 2650 call will cause us loss. The former has unlimited profit while the later has unlimited loss potential but our profit shall remain higher than the loss incurred. Price appreciation in 2600 strike shall be greater than 2650 strike.
Maximum Profit we may make = Higher Strike – Lower Strike – Net Cost
= 2650 – 2600 – 18 = 32 [ 32 X 125 = ₹ 4000 ]
Maximum Loss if incurred = Lower strike premium – higher strike premium
= 37 – 19 = 18 [18 X 125 = ₹ 2250]
Breakeven Point = Lower strike + Net Premium
= 2600 + 18 = 2618
To create call bull spread, we may choose in-the-money or out-of-money options. Depending upon that combination,the strategy may be assigned as aggressive or conservative.
– You may choose both in-the-money call option – conservative
– One is in-the-money while the other is out-of-money call option – moderately aggressive
– Both out-of-money call options – highly aggressive strategy.
Bull Put Spread – With bullish view on underlying security, you may want to earn profit by betting on price fall in put options too. For that, you create bull put spread.
Here, you sell a put option of higher strike, pocketing the option premium. To minimize the risk of adverse price move, you buy a lower strike put option. For that, you pay option premium.
See the second upper figure to understand with example. Expecting up move in TCS, we may choose to sell 2600 strike put option at price of ₹ 48 (more precisely 47.8). To lower the risk, we buy 2550 strike put option at ₹ 26.
Maximum Profit we make = Premium Received – Premium Paid
= 48 – 26 = 22 [ 22 X 125 = ₹ 2750 ]
Maximum Loss incurred = Higher Strike – Lower Strike – Net Premium
= 2600 –2550 – 22 = 28 [ 28 X 125 = ₹ 3500 ]
Breakeven Point = Higher Strike – Net Premium
= 2600 – 22 = 2578
Its so good of you to explain how to buy and sell option security in this post! I enjoyed it even though the calculations are somewhat technical. Nevertheless, it sure would be helpful to stick with the formula!
I shared this comment in kingged.com where this post about Option Trading was found.