The strategy called Bull Call Ladder can be initiated on expectation that the Bank Nifty would break past its record high of 32,613.1 made on December 30, 2019 in the current derivative series which expires on January 28. The index closed at 31,797.90 on Wednesday, just 2.6 per cent short of the all-time high.
The ladder is implemented by buying one call option at 32,000 level and selling two calls at 32,500 and 33,000 with the view of a 1,000-1,200 point rise in the index this month from Wednesday closing.
A call option is purchased when a participant expects an underlying stock or index to rise. Since for every buyer there has to be a seller, a call is sold by a participant who doesn’t expect the market to rise above the level sold plus the premium received from the call buyer.
Since indices are not deliverable only the difference is settled between buyer and seller.
Assuming Wednesday closing rates, the trader buys the 32,000 call for Rs 736 a share ( 25 shares make one contract) . She simultaneously sells a call at 32,500 for Rs 524 and one at 33,000 for Rs 355. By selling calls, she receives an inflow of Rs 879 a share.
This more than covers the upfront cost of the 32,000 call. Actually, after buying the 32,000 call the trader is left with credit of Rs 143. Thus, even if Bank Nifty expires below 32,000, the trader gets to keep Rs 143, as apart from the purchased call, the sold ones expire worthless.
Maximum profit of 500 happens at 32,500 and 33,000. At 32,500 expiry level , the 32,500 call and the 33,000 call become worthless while the 32,000 call is worth Rs 500. This is the gain for the trader.
At 33,000, the 32,000 call is in the money by Rs 1,000 while the sold 32,500 call is worth Rs 500 and the 33,000 call expires worthless. After paying the 32,500 call buyer Rs 500, the trader is left with Rs 500.
The risk of unlimited loss begins only if Bank Nifty expires significantly above 33,500 as the trader has sold an extra call at 33,000. Rohit Srivastava, founder, IndiaCharts, expects Bank Nifty to hit 33,000 this month. “The strategy makes sense since Bank Nifty is unlikely to rise significantly above 33,000 this month,” he said.
Abhishek Karande, CMT senior analyst, Reliance Securities, expects HDFC Bank, ICICI, Axis and SBI to drive the Bank Nifty to a new high of 33,000 this month.