OptionsTalk: Understanding Call Spreads

OptionsTalk: Understanding Call Spreads

by | May 5, 2024 | General

In the volatile realm of the stock market, where trends can swiftly change course, employing the right options strategy is paramount to capitalize on upward movements effectively. While some strategies like strangles may have their merits in certain market conditions, they often prove inadequate during strongly trending markets.

Let’s delve into why strangles may fall short in such scenarios and explore an alternative approach that aligns better with riding the bullish wave: Call Spreads.

Short Strangles, a popular options strategy, involve selling both a call option and a put option with the same expiration date but different strike prices. The goal is to profit from significant price movements, regardless of their direction. However, during strongly trending markets, where prices consistently move in one direction, the limited profit potential and the risk of losses from one side of the trade become evident.

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Call Spreads

To overcome the limitations of strangles in trending markets, traders often turn to call spreads, a strategy that offers a more focused approach to capturing upward movements. Call spreads involve buying a call option while simultaneously selling another call option with a higher strike price, both with the same expiration date. This creates a capped risk and a capped reward scenario, making it ideal for bullish forecasts in trending markets.

Illustration:

Let’s illustrate the concept with an example using fictional stock XYZ, currently trading at INR 100. Suppose an investor believes XYZ will continue its upward trajectory over the next month and decides to implement a call spread strategy. This can be done as under:

BUY XYZ  call option with a strike price of INR 105 for a premium of INR 3 and simultaneously sell one XYZ call option with a strike price of INR 110 for a premium of INR 1. By doing so, they create a call spread with a net debit of INR 2 (INR 3 – INR 1)

Here’s how the payoff diagram of this call spread strategy would look like:

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By utilizing a bull call spread, the investor can benefit from the bullish trend of XYZ while limiting their downside risk. Unlike strangles, which may suffer from diminishing returns in strongly trending markets, call spreads offer a more focused and controlled approach to leverage the upward momentum.

In conclusion, when navigating through a bullish market characterized by strong trends, it’s essential to choose options strategies that complement the prevailing market conditions. While strangles may offer versatility in certain scenarios, call spreads emerge as a preferred choice for capitalizing on upward movements with defined risk and reward parameters. By understanding the nuances of different options strategies and their suitability to market conditions, traders can enhance their chances of success and maximize their gains in a trending stock market.

Foram Chheda, CMT

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Diwali Delight: Top Stock Picks for Prosperous Portfolios

Diwali Delight: Top Stock Picks for Prosperous Portfolios

by | Nov 12, 2023 | General

Embrace the spirit of Diwali with a portfolio that shines as bright as every festive light! Jumpstart the celebratory season with an insightful gaze into our top Diwali stock picks, tailored to offer attractive returns over the coming 12 months. Empower your investment decisions and witness your wealth flourish like never before. So, let’s light up your financial year with a bang!

IDFC First Bank (IDFCFIRSTB):

IDFC FIRST Bank, a prominent player in the banking sector, emerged through the merger of erstwhile IDFC Bank and erstwhile Capital First on December 18, 2018. This financial institution is currently undergoing a transformative journey, transitioning from a corporate-focused, low Net Interest Margin (NIM) bank to a retail-focused, high NIM bank.

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Business Expansion and Diversification:

In the fiscal year 2022, IDFC FIRST Bank demonstrated strategic agility by scaling up various business operations. Noteworthy expansions include Digital Cash Management solutions, Trade Forex, wealth management, FASTag, toll-acquiring business, and credit cards. The bank has also introduced new variants of current accounts, showcasing a commitment to diversifying its offerings and catering to a broader customer base. 

Technical Analysis:

Technically, IDFC FIRST Bank’s stock exhibited a commendable uptrend, rallying from the lows of 28 levels in June to 100 in October of this year. However, after reaching a peak, the stock is currently undergoing a corrective decline which is as of now equal to approximately 23.6%, according to Fibonacci retracement levels. While this corrective move may extend a bit from the current levels until the stock forms and confirms a base for itself, this correction has positioned the stock at an attractive investment level, providing an enticing entry opportunity for savvy investors. 

Volume and On-Balance Volume (OBV) Analysis:

Reassuringly, the corrective decline in the stock has been accompanied by an average increase in trading volume, reinforcing the overall uptrend. The On-Balance Volume, a key indicator of buying and selling pressure, continues its upward trajectory, further supporting the bullish sentiment and confirming the participation of volumes in the up move. These technical indicators signify sustained market interest and confidence in the stock. 

Moving Averages and Investment Strategy:

Currently, IDFC FIRST Bank’s stock is trading above its 50-week, 100-week, and 200-week Moving Averages (MA), indicating a robust underlying bullish trend. A prudent investment strategy would involve allocating 50% of the intended investment at the current levels. Further opportunities for investment may arise at lower levels around 73, representing a 38.2% retracement according to Fibonacci levels and coinciding with the 100-week MA. The potential target for investors could be set around 105. This translates into an expected price appreciation of 23.50% from the current levels. 

Conclusion:

In conclusion, IDFC FIRST Bank not only stands at the forefront of strategic business evolution but also presents a compelling technical investment opportunity. The correction in the stock price, coupled with supportive volume indicators and a bullish trend confirmed by moving averages, positions the bank as an attractive prospect for investors. As always, careful consideration of risk tolerance and market conditions is essential for making informed investment decisions. Investors eyeing long-term growth and a dynamic banking sector may find IDFC FIRST Bank worthy of strategic consideration.

NMDC

NMDC Ltd, a mid-cap player engaged in the exploration and production of Iron Ore, Diamond, Sponge Iron, and Wind Power generation, is currently standing out in the market with a compelling technical setup. A recent breakout in the stock price from its previous high on a weekly closing basis suggests a potential upmove of nearly 16%, making it an attractive prospect for investors.

Technical Resilience:

NMDC Ltd experienced a notable rebound after forming a bottom near Rs. 76 levels. This recovery was not merely a price correction but was accompanied by a significant technical shift. The stock surged above its 50-day, 100-day, and 200-day Moving Averages (MA), indicating a robust bullish trend. The continuous formation of higher tops and higher bottoms further solidifies the positive momentum, showcasing the stock’s resilience and strength.

Recent Price Action:

About a month ago, NMDC Ltd faced a corrective decline after testing the previous high of Rs. 164. However, the stock swiftly resumed its upward trajectory toward the resistance level. Last week marked a pivotal moment as NMDC Ltd not only broke through this defined resistance but also closed higher, creating lucrative buying opportunities for investors.

Volume Surge:

A noteworthy aspect of this breakout is the accompanying surge in trading volumes. Increased volume during a price rally is a strong indicator of market conviction, supporting the bullish case for NMDC Ltd. This surge in activity suggests heightened investor interest and reinforces the potential for an extended uptrend.

Relative Strength and Benchmark Outperformance:

Adding to the positive sentiment, NMDC Ltd’s Relative Strength has outperformed the benchmark Nifty 500 index. This relative outperformance underscores the stock’s strength compared to the broader market, bolstering its attractiveness for investors seeking opportunities in a dynamic market environment. The RS line for NMDC against the Nifty 500 Index is in a strong uptrend and above its 50-period MA.

Conclusion:

In conclusion, NMDC Ltd presents a compelling investment opportunity based on its recent technical setup. The breakout from the previous high, coupled with the stock’s strong move in the recent past, volume surge, and outperformance against the benchmark index, positions it favourably for a potential upside of close to 16% from current levels over the next 12 months. Investors looking for a well-rounded mid-cap stock with a promising technical setup may find NMDC Ltd worthy of consideration. As with any investment decision, careful analysis and risk management are crucial, but the current technical indicators strongly support a bullish outlook for NMDC Ltd over the coming months.

– Foram Chheda, CMT