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.

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:

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