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Index Strategy: Bear spread to play the market weakness

Srividhya Sivakumar

The steep decline in Nifty last week appears to have turned the market mood on its head, from a positive growth one to the present dilly-dallying, doubtful one. Besides, with the earnings season now behind us there is also little to speak of in terms of near-term upside triggers for the market. In keeping with the sombre mood, we suggest traders to set a bear put spread on the index to benefit from further weakness. You can do this by buying Nifty November 4,700 put option and simultaneously selling Nifty November 4,600 put. This would result in a net initial debit as the strategy involves buying in the money put as against selling one that is out of money. In this case, you will have to shell out Rs 138 for buying Nifty November 4,700 put while you will receive Rs 97 when you write Nifty November 4,600 put. On the whole, the spread will cost you Rs 41/share. 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 depending on the day’s market movement.

Maximum profit potential: The maximum profit for this spread will occur when Nifty moves below the strike price of the sold option, i.e. 4,600. 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 59 [(4,700-4,600) – Rs 41].

Maximum loss potential: When your spread is totally out of money i.e. when Nifty value is higher than the 4,700, the maximum loss that you can suffer will be limited to the net debit paid, Rs 41 – 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 41 to earn a maximum profit of Rs 59. Traders with a slightly more bearish view can tweak the strike prices further low using Nifty November 4,700 put and Nifty November 4,500 put. The spread will entail an initial cost of Rs 71 for a maximum profit potential of Rs 129.

When to exit?

Traders should consider booking profits and closing the positions as soon as the underlying trends below the strike price of the sold put option. But in the meanwhile, if you feel that the likelihood of the underlying moving down is low, you can consider closing the position prematurely.

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