A Bull Call Spread is a directional strategy and is used when bullishness is expected in the stock/index chosen. At the same time the trader is sure that although bullishness is expected, the stock/index might face resistance at certain point in future.
To take advantage of this situation, the trader buys one in the money call and sells one out of the money call. Expiry of both the strikes and the underlying stock/index will be same.
On Oct 4 2017, AjantaPharma is trading at 1150 rupees. I’m sure that this stock is going to go up in this month. At the same time 1300 is the strongest resistance that the stock might face.
In this situation, I will buy 1140 CE of Oct Expiry and sell 1300 CE of Oct Expiry. To reduce my cost of purchasing, I am selling a call option and will receive premium from the buyer.
On October 4 2017, 1140CE was trading at 55 rupees roughly and 1300 CE was trading at 7.
So my total cost here would be 55-7=48 rupees.
If by expiry Ajantapharma reaches 1300, I will receive profits from 1140CE. Since I also sold 1300CE and the underlying didn’t cross the strike price, I will retain the premium received from the buyer.
Let’s see the payoff diagram now
|AjantaPharma at Expiry (S)||Payoff from 1140 CE||Payoff from 1300 CE||Net Payoff|
As seen above, the profit and loss is capped in this strategy.