The Hindu Business Line : Markets looking weak? Set a bear put spread

Placing option bets in a highly volatile market requires you to have an unusually high appetite for risk. But when markets are volatile and worse still have a mind of their own, beating it can become that much more difficult and risky – a situation similar to what we have in our hands presently. Nifty appears to be in a crucial juncture at this point. After an impressive up-move from its October lows, it may soon run out of steam. At this point, the bias definitely appears negative and hence we suggest traders with little stomach to brace such volatility to set for themselves a bear put spread.

How to set the bear put?

Set a bear put spread using Nifty November Put options with strikes 2900 and 2600. You can do this by buying Nifty Nov 2900 put option (in-the-money) and simultaneously selling Nifty Nov 2600 put (out-of-money). Now since the strategy involves buying in the money put as against selling one that is out of money, it will result in an initial debit.

In this case, you will have to shell out Rs 200 for buying Nifty Nov 2900 put while you will receive Rs 67 when you write Nifty Nov 2600 put. So, in all, this will involve an initial net debit of Rs 133, which will be your cost of setting the spread. While it is advisable to execute both the legs of the strategy simultaneously to benefit from lower margin money requirement, you can time the purchase and sale of options on Monday depending on the day’s market movement.

Risk-return payoff

Essentially a low-risk and low-return strategy, this spread will deliver range-bound returns depending on the price movements of Nifty.

Maximum profit potential: The maximum profit for this spread will occur when Nifty moves below the strike price of the sold option, i.e. 2600. The maximum profit potential will be limited to the difference between the two strikes minus the net debit paid or the cost of setting the spread. In this case, the maximum profit will be Rs 167 [(2900-2600) – Rs 133].

Breakeven point: The breakeven for the spread lies between the strike prices of the put options that have been transacted. In this case, it will be at 2767 points (2900 -133).

Maximum loss potential: When your spread is totally out of money i.e. when Nifty value is higher than the 2900, the maximum loss that you can suffer will be limited to the net debit paid, Rs 133 – that is the money that was spent initially in setting the bear put spread.

So, in essence you will be taking a maximum risk of Rs 133 to earn a maximum profit of Rs 167.

Note that this can be changed by tweaking the strike prices of the options involved. Traders with a slightly more bearish view can consider setting bear put using Nifty 2800 and 2600 puts. This spread can be set for an initial debit of Rs 85 and enjoys a maximum profit potential of Rs 115. The only fallout will be that the breakeven point will be pushed a little lower to 2715 points in this spread.

When to exit?

Since the maximum profit that can be earned though this strategy is limited, traders should consider booking profits and closing the positions as soon as the underlying trends below the strike price of the sold put option.

On the downside, if you feel that the likelihood of the underlying moving down is low, you can consider a premature closing of positions before hitting the maximum loss scenario.

— Srividhya Sivakumar

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