Spread strategies are amongst the easiest to execute amongst option traders. They involve two or more options which means multiple transactions must be placed in order for the strategy to take place.
Strategies such as the ‘Bull Call Spread’ should be employed when your view of a specific stock or index is less than ‘aggressive’, like for instance if you have a ‘moderately bullish’ or ‘moderately bearish’ attitude
There are various situations where one may become somewhat optimistic. These are detailed here:
Reliance Industries is expected to announce their Q3 quarterly results shortly. The management’s guidance from their Q2 quarter suggests the results will surpass those of the same time period last year. Although it is not yet known by how much, this is the missing piece of the puzzle.
The result announcement should prompt a positive reaction in the stock price. However, since the guidance had already been reported during Q2, the market may have already taken it into account. Consequently, there could be a mild increase, with not much room for further growth.
The stock you are following has been heading south for some time, reaching a 52-week low, testing the 200 day moving average and nearing a multi-year support. While this may translate into a potential recovery, bear in mind that it is still in a downtrend.
The quantitative perspective of the stock shows a stable mean reverting habit, typically fluctuating between the first standard deviation up and down. However, in the recent dip the price has plummeted to 2nd SD with no fundamental cause. Because of this there’s a good chance it will return to its normal range eventually, making for a bullish outlook. But, as it could remain longer at that level before going back, this limits one’s optimism about the stock.
The point here is that you can express a bullish or bearish opinion through any of the theories (fundamental, technical, or quantitative). A spread strategy could be put in place to set up option positions accordingly so as to take advantage of this outlook.
You safeguard yourself against potential losses should your prediction be incorrect.
The profit you make is pre-determined.
Rather than having your profits capped, you gain the opportunity to invest with a lower cost.
The third point may appear to be complicated now, however it will become more clear as we move forward.