An­a­lysts Favour a Bull Call Spread

The Economic Times - - Smart -

Mum­bai: Deriva­tives an­a­lysts are ad­vis­ing clients to do a bull call spread on SBI in light of the bank beat­ing Street es­ti­mates on both prof­itabil­ity and as­set quality in the third quar­ter. The stock, which has risen 10% over the past 22 trad­ing ses­sions on an­tic­i­pa­tion of a strong Q3 show and ac­crual of low­cost de­posits be­cause of de­mon­eti­sa­tion, has po­ten­tial to rise by an­other 4-5% be­fore deriva­tives ex­piry on Fe­bru­ary 23, they said.

Ex­perts also said that the strat­egy is favourable be­cause it has a 1:3 risk re­ward ra­tio, thanks to ex­piry of the Fe­bru­ary se­ries of deriva­tives be­ing less than 10 days away.

The strat­egy com­prises buy­ing an SBI call op­tion of ₹ 275 strike and sell­ing two call op­tions of the ₹ 290 strike.

The aim be­hind sell­ing two ₹ 290 strike op­tions is to pocket pre­mium and cut cost of the ₹ 275 op­tion on ex­pec­ta­tion that the stock will not rise above ₹ 290 in the time frame of the strat­egy. Thus, while a gain would ac­crue on the ₹ 275 call , the sold ₹ 290 calls would ex­pire worth­less.

Round­ing off Fri­day’s clos­ing price, the client would have to shell out ₹ 7/share for the ₹ 275 strike. How­ever, since she sells two ₹ 290-strike calls for ₹ 4, the cost of the pur­chased op­tion is just ₹ 3/share.

The max­i­mum profit is ₹ 15, while losses be­gin (since two op­tions have been sold) af­ter ₹ 305. How­ever, SBI, which closed flat at ₹ 275 on Fri­day is ex­pected to face stiff re- sis­tance around ₹ 288-289 (its 52week high) in the cur­rent se­ries. For sim­plic­ity, all prices ex­clude bro­ker­age and taxes.

The breakeven for the ₹ 275 call is ₹ 278 (`3 op­tion cost) . If the stock ends at ₹ 288 at ex­piry, you make a lit­tle more than three times amount in­vested (`3). If the stock ends be­low ₹ 275 at ex­piry, all the calls end out of the money and your loss is a debit of ₹ 3.

The bro­kers’ con­fi­dence of the 1:3 risk-re­ward gains currency be­cause closer to ex­piry, op­tions lose value due to time de­cay, or theta.


“Here we are bank­ing on the ro­bust Q3 re­sult lift­ing the stock by a mod­er­ate 4-5% over the next week or so, while theta si­mul­ta­ne­ously erod­ing value of the ₹ 290 calls,” said San­jiv Bhasin, EVP, mar­kets and cor­po­rate af­fairs, IIFL.

SK Joshi, head of wealth man­age­ment at Kham­batta Se­cu­ri­ties agrees.

In­ci­den­tally, the SBI deriva­tives counter wit­nessed a 20% spurt in open in­ter­est or traders’ out­stand­ing po­si­tions to 51,644 con­tracts on Fri­day post Q3 re­sults. This was the high­est among all un­der­ly­ing stocks on NSE.

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