Option strategies- Bull spread

Bull spread

Salient Featuresa) Market is expected to go up.
b) Limited profit or loss. 

Introduction:

Bull spread is used when the market is likely to go up, it can be created in two ways which are given below: 1st Buying a call of lower strike price and selling a call of higher strike price:- When an investor, expecting the market to go up, creates a spread by purchasing a call and selling another call of higher strike price. If the market moves upwards after the creation of spread, investor makes profit otherwise he loses. Let us take an example to understand this in detail- an investor takes following spread on 27th May 2005 when Nifty Spot was Rs. 2050. Action Option type Strike Premium Total investment Long Call 2000 84 Short Call 2100 24 60

Here he buys a Nifty call of Strike price Rs.2000 and sells a call of Strike price of Rs. 2100 (Higher strike price). For creating this spread he pays a net amount of Rs.60 as premium (Rs.84 paid for long position and Rs. 24 received from short position). Now, his cash flow at different levels of Nifty closing on 30th June05(last Thursday of the following month) are as follows: Index Long call Short call Investment Cash flow 1940               -              -   -60                      (60) 1970               -              -   -60                      (60) 2000               -              -   -60                      (60) 2030               30            -   -60                      (30) 2060               60            -   -60                        -   2090               90            -   -60                       30 2120             120           (20) -60                       40 2150             150           (50) -60                       40 2180             180           (80) -60                       40

Here we find that maximum profit and loss that he can incur are limited, thus it has low level of risk (lesser profits also). If he goes right in predicting the trend, then on an investment of Rs.60, he can earn Rs. 40. 2nd Buying a put of lower strike price and selling a put of higher strike price:- When an investor, expecting the market to go up, creates a spread by purchasing a put and selling another put of higher strike price. If the market moves upwards after creation of spread, investor makes profit otherwise he loses. Let us take an example to understand this in detail- an investor takes following spread on 27th May 2005 when Nifty Spot was Rs. 2050.   Action Option type Strike Premium Total investment Long Put 2000 18 Short Put 2100 59 -41 Here he buys a Nifty Put of Strike price Rs.2000 and sells a put of Strike price of Rs. 2100 (Higher strike price). For creating this spread he receives a net amount of Rs.41 as premium (Rs.18 paid for long position and Rs. 59 received from short position). Now, his cash flow at different levels of Nifty closing on 30th June05(last Thursday of the following month) are as follows:  Index Long Put Short Put Investment Cash flow 1940               60        (160) 41                      (59) 1970               30        (130) 41                      (59) 2000               -          (100) 41                      (59) 2030               -            (70) 41                      (29) 2060               -            (40) 41                         1 2090               -            (10) 41                       31 2120               -             -   41                       41 2150               -             -   41                       41 2180               -             -   41                       41 Here we find that maximum loss and profit that he can incur are limited, thus it has low level of risk (lesser profits also). If he goes right in predicting the trend, then on an investment of Rs.41, he can earn Rs. 41.