I believe you have gone through earlier articles to understand the basis and basics of option strategies. Today I am going to explain the most basic and widely used option strategy that one can use to lower the option cost.
Strategy Name: Bull Call Spread
When to apply this strategy: When your Outlook on Market / Stock is slightly Positive i.e. you expect an upside but not of really great significance (e.g. 20% + movement)
Strategy Transactions: Buying ATM Calls and simultaneously selling and OTM call on same security for same series.
E.g : Say Suzlon Energy is to declare debt re-structuring plans in next AGM and current price is 8. You see a potential of 10% to 15% move but don’t anticipate that stock will cross 10 at any cost at least in this series.
You Buy call for 8.5 @ 2 ( Lot size = 45000) = Premium Paid = 90,000
You Sell call for 12 @ 0.5 ( Lot size = 45000 ) = Premium Recvd = 22,500
Net premium paid = 67,500
So you see your option cost is reduced by 25% .
Risks & Benefits :
This option strategy requires selling a call and hence margin deposit and maintenance is required
If Buy call option expires worthless you will have a loss capped to ( premium paid – premium received i.e 67,500)
If stock goes above 12 , you will lose on the upside but will gain on the Buy Call of 8 and keep the premium that you earned from selling the call of 12 ( you will have notional loss on sell call) .
If the stock closes at 11 on expiry, you earn on the buy call and keep the premium for the call you sold on strike of 12
Max Loss and Max Profit is defined and capped since you are buying and selling a call on the same security for same series.