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Ratio Call Spread-Neutral Strategy

High volume price breakout stocks: IRCTC, REC LTD, COAL INDIA and PFC

Explanation

Ratio call spread is implemented by traders who are neutral on the market and bearish on the volatility in the near future. The strategy involves buying a number of options and selling more than the bought options of the same underlying stock and expiration date at a different strike price. The decision of the ratio between the long and short option contract is at description of the strategy implementer but the most common ratios are 2:1, 3:2, and 3:1.

Reward:

Maximum profit potential for the strategy is limited and is made when the underlying stock price at expiration is at the short option strike price. At this price, both the written calls expire worthless while the long call expires in the money.

Risk:

Loss potential situation can occur when the stock price makes a strong move beyond the upper breakeven point. As the price marched toward upside, there is no limit to the maximum loss.

Construction

Buy 1 ITM Call Option

Sell 2OTM Call Options

Option Type Expiry Date Strike Price LTP Action No. Of Lots
CALL 27/04/2023 17650.0 150.05 Buy 1
CALL 27/04/2023 17800.0 45.15 Sell 2

 

Market Expiry Payoff 1 Payoff 2 Net Premium Option PayOff At Expiry
17400.0 0.0 0.0 -59.75 -59.75
17450.0 0.0 0.0 -59.75 -59.75
17500.0 0.0 0.0 -59.75 -59.75
17550.0 0.0 0.0 -59.75 -59.75
17600.0 0.0 0.0 -59.75 -59.75
17650.0 0.0 0.0 -59.75 -59.75
17700.0 50.0 0.0 -59.75 -9.75
17750.0 100.0 0.0 -59.75 40.25
17800.0 150.0 0.0 -59.75 90.25
17850.0 200.0 -100.0 -59.75 40.25
17900.0 250.0 -200.0 -59.75 -9.75
17950.0 300.0 -300.0 -59.75 -59.75
18000.0 350.0 -400.0 -59.75 -109.75
18050.0 400.0 -500.0 -59.75 -159.75
18100.0 450.0 -600.0 -59.75 -209.75
18150.0 500.0 -700.0 -59.75 -259.75
18200.0 550.0 -800.0 -59.75 -309.75

 

Payoff Chart

 

Example

Suppose, the Nifty indices is currently trading at 17800 levels and the trader sees Nifty trading range bound and holds a bearish outlook for the volatility till the expiry. The trader executed ratio call spread, which involves buying 17650 ITM call option and selling 2 17800 OTM calls. The net fund outflow initially would d be equal to Rs. 3000 (150 – (45*2))*50.

Scenario 1:

If instead of range bound market scenario the market turns bearish and fell to 17550 levels. The trader will loss the initial new premium paid and the loss would be equal to Rs. 3000.

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    Scenario 2:

    If the market moves as per the expectation of the trader and remain range bound and closes near to short OTM call option strike price. The trader will gain from long option and the short call will expire worthless. Total potential gain would be equal to Rs. 4500.

    Scenario 3:

    Due to whatever news, the indices made a volatile move on to the upside and closes above he short call option the trader loss will start to make losses on its short positions as the indices rises.

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