Mumbai: Wealthy traders with a risk appetite could initiate a bull call ratio spread on Nifty options ahead of the February 1 Union Budget to play for a potentially favourable riskreward, said derivatives analysts. The recent correction makes the play more favourable, they added, as the cost of the calls has come down.
The call ratio strategy consists of buying one 12,200 Nifty call and simultaneously selling two 12,600 calls expiring on February 27. The sale of the two, deeper out-of-themoney (OTM) calls greatly reduces the upfront cost of the 12,200 call but exposes the trader to unlimited risk if the market rises sharper than expected. Thus, placing a stop loss at the upper breakeven point or below it is imperative.
Using Tuesday provisional prices, the sale of the two 12,600 OTM calls yields the trader a combined Rs 106 a share (75 shares make one contract), reducing the 12,200 call cost from Rs 184 to Rs 78 (184-106). This is the maximum loss and happens if the Nifty expires at or below 12,200 next month.
The maximum profit of Rs 322 (12,600-12,200-78) happens if the Nifty expires the series at 12,600. Unlimited losses ensue if the Nifty moves above 12,922, or 7 per cent more from January 28’s closing of 12,060, as an extra call has been sold at 12,600. To guard against that a stop loss could be placed at 12,922 or even below, at, say, 12,700.
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If a trader chooses to square of preexpiry at 12,600, she would get at least Rs 160 as the prices of the sold 12,600 calls also rise along with that of the 12,200 call.
If she holds until expiry, and the Nifty ends at 12,600, the 12,200 call is worth Rs 400 and the sold 12,600 calls expire worthless. After adjusting for the debit, the trader gets Rs 322 (400-78).
However, every point of rise post 12,600 until 12,922 reduces the profit, which, at 12,922 becomes nil. Beyond that, unlimited losses begin unless the trader places a stop loss. Assume the Nifty expires at 13,000 in the February series, the 12,200 call is worth Rs 722 (800-78) and the two, 12,600 sold calls are worth a combine Rs 800. The loss for the trader after paying the call option buyers is Rs 78.
Amit Gupta, derivatives head at ICICI Securities, said he has recommended the strategy to his clients and expects it to yield “tidy profits” even if squared off prior to expiry. Chandan Taparia of Motilal Oswal Financial Services said the strategy could be held till expiry of the February series, on expectations of the Budget being favourable from the “market point of view”.
However, Hormuz Maloo, director AFco Investments, thinks that the Nifty could test 11,800-11,850 levels initially if “nothing really material” emerges from the Budget.
Source: Economic Times
