The Hindu Business Line : Trading Strategy: Set a Bear Put Spread

The bias still appears negative regardless of the gains posted by the market in the run up to the Budget. We feel this fizz may be short-lived, unless of course the Budget announcement comes with surprise initiatives that can significantly cheer the markets up.

Given this backdrop, traders can consider setting a bear put spread for the week to benefit from any negative undertone in the market. This bear put spread can be set using Nifty February put options with strikes 3050 and 2800. You can do this by buying Nifty Feb 3050 put option (closed at Rs 139) and simultaneously selling Nifty Feb 2800 put (closed at Rs 35).

The spread will leave you with an initial debit of Rs 104 per lot, which is also the 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 will occur when Nifty moves below 2800. The maximum profit, however, will be limited to the difference between the two strikes minus the cost of setting the spread. In this case, the maximum profit will be Rs 146 a lot [(3050-2800) - Rs 104].

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 2904 points (3050 -146).

Maximum loss potential: When your spread is totally out of money i.e. when Nifty value is higher than 3050, the maximum loss that you can suffer will be limited to the money that was spent initially in setting the bear put spread i.e. Rs 104. So, in essence you will be taking a maximum risk of Rs 104 to earn a maximum profit of Rs 146 per lot.

Note that traders with a slightly less bearish view can consider setting bear put using Nifty 3050 and 2850 puts. This spread can be set for an initial debit of Rs 92 and enjoys a maximum profit potential of Rs 108. The breakeven point in this case will higher up at 2941.

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 even before it hits the maximum loss scenario.

Srividhya Sivakumar

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