A bull spread is created when the underlying view on the market is bullish, but not extremely bullish. Considering this situation, the trader would also like to buy a call option (to capture the bullish stance) but would also, not want to spend on option premium, so to avoid the steep option premium cost, would like to take a contrary position in call options.  Only a purchase of a naked call means, expectation of a rapid bullish move in Nifty or the underlying, but if the bullish view going to take time to materialise, then the contrary position in call option of a different strike can help protect the overall NSE option strategy from a drop in time value of the option. (also, referred to as theta decay, in options Greek terminology, which shall be explained later).

So, the trader buys a call position with lower strike and sells a call option with higher strike. As lower strike call will cost more than the premium earned by selling a higher strike call, although the cost of position reduces, the position is still a net cash outflow position to start with. A net debit spread strategy, as it is also called. This is what is commonly known as Bull Call Spread.

Secondly, as higher strike call is shorted, all gains on long call beyond the strike price of short call would stand negated by losses of the short call, i.e. if the prices of the underlying Nifty or F&O stock were to rise beyond the strike price of the short call, the profits would flatten out, as the gains from the buy option position would stand negated from the sell position. Hence the profits in this strategy are limited and the loss also is limited to net premium outflow, if prices of Nifty or F&O stock (underlying) were to fall below the strike price of the long call.

The higher strike price, at which the second leg of the strategy is executed can be varied, but one has to remember, higher the strike price, lower is its call premium and lesser the premium inflow from this specific short leg.

Quantsapp option architect helps traders formulate varied option strategies. Consider a bull call spread where Nifty Futures fair value is quoting at 17578, trader shall

Buy 17600 8 Sep 2022 CE at 171

Sell 17800 8 Sep 2022 CE at 87

It’s a net debit strategy with premium outflow of about Rs 4,200, as also indicated in the tool of Quantsapp. The expiry payoff is indicated in orange colour. Expiry BEP of the strategy is at 17,684.

The maximum loss begins at about Nifty level of 17,600 and is about Rs 4,200; while the maximum profit of the Nifty option strategy is at 17,800 and thereafter, which is capped at Rs 5,800.

If an option trader is bearish on the market and decides to buy a put option by paying the necessary option premium, but desires to reduce the outgo, by selling another put option of a different strike price, i.e. of a lower strike price, it is a bear put spread. An option strategy that would benefit the option trader from a bearish move in Nifty or F&O stock (underlying), but at the same time the profits would be capped at the price the lower strike put option has been sold. The ideal forecast for this option strategy is being bearish with a mediocre pace, because if the option trader was almost certain about a sharp fall, then he would be better off in just buying a naked put. But if the bearish forecast is going to take time to materialise, then the lower strike put is sold to make the option strategy slightly immune to drop in time value of option (theta decay, which shall be explained in separate module on option greeks).

So, it’s not just the direction but also the pace and timing of the direction which is of paramount importance while, crystallising on a particular option strategy, in this case, a bear put spread. By buying a put option which is of a higher strike price and simultaneously selling a put option of a lower strike price results in a premium outgo, albeit at a smaller quantum. This is a debit option spread.

Consider a bear put spread where Nifty Futures fair value is quoting at 17,578, trader shall

Buy 17600 8 Sep 2022 PE at 191.80

Sell 17550 8 Sep 2022 PE at 168.90

It’s a net debit strategy with premium outflow of about Rs 1,145, as also indicated in the tool of Quantsapp. The expiry payoff is indicated in orange colour. Expiry BEP of the strategy is at 17,578.

The maximum loss begins at about Nifty level of 17,636 and is about Rs 1,145; while the maximum profit of the Nifty option strategy is at 17,516 and below, which is capped at Rs 1,355.

Trending markets is a phenomenon that comes along for just few months in a year. The remnant time, there is a serious lack of momentum in the markets. These are times when the markets are so range bound or oscillating that the buy and quickly exit option strategy just doesn’t work. These are the times (market regime) when money is made out of selling options or writing options. However, a lot of people are hesitant to Option writing or may have lost a few times in writing options/selling options.

Well, we do not need to do that anymore because the Big Unlimited Losses that everyone is afraid of while writing options can be turned into a Limited loss and more importantly Known Loss strategy. The way to do so is by turning to Credit Spreads every time you see an opportunity to write options.

It is not much different from writing. With Credit Spreads we could write the same strike options or even closer to the current market. However, traders would like to add another leg of buying a higher strike call against a call sold or a lower strike put against a put sold.

For Example: Let us say Nifty is at 17500, following are the Options Prices

17500 CE @ 150

17600 CE @ 104

17700 CE @ 68

17800 CE @ 44

With a view of writing Calls, one would go for writing (selling) a slightly away Call of 17700 @ 68 with an unlimited loss profile.

Instead, we can Sell 17600 @ 104 and Buy 17800 @ 44, receiving net premium of 60

While the Premium is lower than the 17700 CE, remember we have cut the maximum loss to a known number now

Difference between strikes – Premium Recvd. = 200 – 60 = 140

Of course, the losses would be much lower than that if the position is exited during the expiry. More importantly we need to pay a lot less margin as compared to a naked sell of an option; when we have added a new leg that creates protection or hedging of the extra unlimited loss risk.

Examples of constructing credit spreads using puts and calls are enlisted ahead.

If the option trader considers the market is bullish, then he would like to sell a put option.  If prices go up, trader ends up in making a profit, i.e. equal to the premium on sold puts. However, in case prices go down, the trader would be facing the risk of unlimited losses. In order to put a floor to the downside risk, he may buy a put option with a lower strike. While this would reduce his overall upfront premium, benefit would be the embedded insurance against unlimited potential loss on short put.

As, in this option trading strategy, the option trader sells a put option of a higher strike price and buys another put option at a lower strike price, it is a net premium receipt strategy or also called as a put credit spread.

Consider a bull put spread where Nifty Futures Fair value is quoting at 17,578, trader shall

Buy 17600 8 Sep 2022 PE at 191.80

Sell 17800 8 Sep 2022 PE at 302

It’s a net credit strategy with premium inflow of about Rs 5,510, as also indicated in the tool of Quantsapp. The expiry payoff is indicated in orange colour. Expiry BEP of the strategy is at 17,690.

The maximum loss begins at about Nifty level of 17,600 onwards and lower of about Rs 4,490; while the maximum profit of the Nifty option strategy is at 17,802 and above, which is capped at Rs 5,510.

Option trader is bearish on the market and so he looks to sell a low strike high premium call option. The risk in a naked short call is that if prices rise, losses could be unlimited. So, to prevent his unlimited losses, he longs a high strike call and pays a lesser premium. Thus in this strategy, he starts with a net option premium inflow.

Consider a bear call spread where Nifty Futures Fair value is quoting at 17,578, trader shall

Buy 17600 8 Sep 2022 CE at 171

Sell 17550 8 Sep 2022 CE at 198.95

It’s a net credit strategy with premium inflow of about Rs 1,398, as also indicated in the tool of Quantsapp. The expiry payoff is indicated in orange colour. Expiry BEP of the strategy is at 17,581.

The maximum loss begins at about Nifty expiry level of 17,636 onwards and higher, of about Rs 1,103; while the maximum profit of the Nifty option strategy on expiry is at 17,516 and below, which is capped at Rs 1,398.

Well, the credit spread is a limited loss strategy, but we do need to remember that the maximum possible profit is always lower than the maximum possible loss in Credit Spreads as well.

Best way to deal with this is by keeping an underlying stop loss in the strategy. Targets are not necessary, but Stop Losses are. If the underlying crosses a certain level invalidating your view, then exit the entire trade no matter what time of expiry it is.

A bull call spread, where option traders buy a CE of lower strike price and sell a CE of higher strike price of the same expiry and same underlying, are said to have executed a vertical call spread.

When option traders buy and sell options of the same type, across different strikes of the same expiry and for the same underlying, are said to have executed a vertical spread.

Depending on the stance, forecast or market perspective, both bullish and bearish vertical spreads can be created.

Directional trade is where there exists a forecast or a preconceived notion of the market and trades/ strategies are created to abide by that forecast. While there are times when the option trader isn’t clear about direction of the market, but is aware of volatility state of the markets, i.e. expectation of high or low volatility exists, during such moments, non-directional option trading strategies are deployed.

If an option trader has a bearish outlook on the market and decides to buy a put option, but desires to reduce the premium outgo, by selling another put option of a lower strike price, it is a bear put vertical spread.