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Spread strategies are done when we have a bullish or a bearish stance in the underlying, but the extent of bullishness or bearishness is not very high.
Let us discuss a the ‘Bull Call Spread’ first .
It is devised when your outlook on the stock/index is ‘moderate’ and not really ‘aggressive’.
So when we are moderately bullish and not aggressive in our view , you would want to devise a strategy with will ensure the below mentioned :
1. You protect yourself on the downside (in case you are proved wrong)
2. The amount of profit that you make is also predefined (capped)
3. As a trade off since u r capping your profits, you get to participate in the market for a lesser cost .
The bull call spread is a two leg spread strategy which involves trading in At the money and Out of the Money.
To implement the bull call spread –
1. Buy 1 ATM call option (leg 1)
2. Sell 1 OTM call option (leg 2)
When you do this , one needs to ensure that
1. All strikes belong to the same underlying
2. Belong to the same expiry series
Say for example a trader is bullish on market so he decides to go long on 8600 strike call option by paying a premium of 500 and he expects market to go not a above 9200, so he takes a short call option and receives a premium of 300. The payoff for various prices will be as shown on the screen.
As we can see from the given example, the loss and profit is both limited. Maximum profit the strategy can generate is 400 and maximum loss is 200.
To conclude, we can say that the bull call spread is a great alternative to simply buy a call outright: keeping in mind when the trader is not aggressively bullish in the underlying stock. It reduces the breakeven price and decreases the capital required to be bullish on a stock, it also is a strategy that takes into consideration realistic expectations.
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