You need to understand that when you buy the option you pay premium. You can afford to pay the premium only when the price movement is going to be big enough to make profits for you after covering the premium cost. If you are moderately bullish on the US Dollar you can do a call spread on the dollar. Here you buy a lower strike call and sell a higher strike call. The premium received on the higher strike call reduces the overall premium paid on the lower strike call and brings down your overall cost of the option strategy. That is the advantage of a call spread and it must be only done when the view on the dollar is moderately bullish. If you are very bullish on the dollar then you are better off buying a call option on the dollar itself. It will be more profitable that way. Thus you can use the call spread only when you are moderately bullish on the dollar or moderately bearish on the rupee as a currency. Check the table below:

Buy Call

72.00

Prem

0.70

Strategy

Call Spread

Sell Call

73.00

Prem

0.40

Buy 72 Call &

Sell 73 Call

Price

Buy Call

Premium

Sell Call

Premium

Net Premium

Buy Call P/L

ITM/OTM

Sell Call P/L

ITM/OTM

Pay-Off

68.00

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

68.50

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

69.00

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

69.50

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

70.00

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

70.50

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

71.00

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

71.50

72.00

0.70

73.00

0.40

0.30

-

OTM

-

OTM

-0.30

72.00

72.00

0.70

73.00

0.40

0.30

-

ATM

-

OTM

-0.30

72.50

72.00

0.70

73.00

0.40

0.30

0.50

ITM

-

OTM

0.20

73.00

72.00

0.70

73.00

0.40

0.30

1.00

ITM

-

ATM

0.70

73.50

72.00

0.70

73.00

0.40

0.30

1.50

ITM

-0.50

ITM

0.70

74.00

72.00

0.70

73.00

0.40

0.30

2.00

ITM

-1.00

ITM

0.70

74.50

72.00

0.70

73.00

0.40

0.30

2.50

ITM

-1.50

ITM

0.70

75.00

72.00

0.70

73.00

0.40

0.30

3.00

ITM

-2.00

ITM

0.70

75.50

72.00

0.70

73.00

0.40

0.30

3.50

ITM

-2.50

ITM

0.70

76.00

72.00

0.70

73.00

0.40

0.30

4.00

ITM

-3.00

ITM

0.70

76.50

72.00

0.70

73.00

0.40

0.30

4.50

ITM

-3.50

ITM

0.70

77.00

72.00

0.70

73.00

0.40

0.30

5.00

ITM

-4.00

ITM

0.70

In the above case, we have simulated the profits and losses on the call spread strategy under various price levels. We can infer the following from the above table:

· The call spread involves buying 72 call at 0.70 and selling a 73 call at 0.40. Hence the net cost of 0.30 will be the maximum loss on this strategy. As you can see in the payoff table, at no point does the total loss go beyond 0.30.

· The idea of selling the 73 call is to reduce the cost of buying the 72 call and this strategy on works when you are moderately bullish on the strengthening of the US dollar or the weakening of the Indian rupee.

· The maximum profit of this call spread is achieved at the higher strike at which the call is sold i.e. Rs.73 strike. As you can see, the maximum profit of 0.70 is achieved at the price level of 73 and after that the profits are flat. Whatever you gain on the 72 call is lost on the 73 call beyond this point.

· This is a good strategy when you are expecting the dollar to strengthen marginally or the rupee to weaken marginally.

Let us tweak the above example a little bit and see what happens if you had sold the 74 strike call option instead of the 73 strike call option at a premium of 0.10? How would it make a difference? Let us check it out?

Buy Call

72.00

Prem

0.70

Strategy

Call Spread

Sell Call

74.00

Prem

0.10

Buy 72 Call &

Sell 74 Call

Price

Buy Call

Premium

Sell Call

Premium

Net Premium

Buy Call P/L

ITM/OTM

Sell Call P/L

ITM/OTM

Pay-Off

68.00

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

68.50

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

69.00

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

69.50

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

70.00

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

70.50

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

71.00

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

71.50

72.00

0.70

74.00

0.10

0.60

-

OTM

-

OTM

-0.60

72.00

72.00

0.70

74.00

0.10

0.60

-

ATM

-

OTM

-0.60

72.50

72.00

0.70

74.00

0.10

0.60

0.50

ITM

-

OTM

-0.10

73.00

72.00

0.70

74.00

0.10

0.60

1.00

ITM

-

ATM

0.40

73.50

72.00

0.70

74.00

0.10

0.60

1.50

ITM

-

ITM

0.90

74.00

72.00

0.70

74.00

0.10

0.60

2.00

ITM

-

ITM

1.40

74.50

72.00

0.70

74.00

0.10

0.60

2.50

ITM

-0.50

ITM

1.40

75.00

72.00

0.70

74.00

0.10

0.60

3.00

ITM

-1.00

ITM

1.40

75.50

72.00

0.70

74.00

0.10

0.60

3.50

ITM

-1.50

ITM

1.40

76.00

72.00

0.70

74.00

0.10

0.60

4.00

ITM

-2.00

ITM

1.40

76.50

72.00

0.70

74.00

0.10

0.60

4.50

ITM

-2.50

ITM

1.40

77.00

72.00

0.70

74.00

0.10

0.60

5.00

ITM

-3.00

ITM

1.40

In the above case, we have simulated the profits and losses on the call spread strategy under various price levels. We can infer the following from the above table:

· The call spread involves buying 72 call at 0.70 and selling a 74 call at 0.10. Hence the net cost of 0.60 will be the maximum loss on this strategy. As you can see in the payoff table, at no point does the total loss go beyond 0.60.

· The idea of selling the 74 call is to reduce the cost of buying the 72 call and this strategy only works when you are moderately bullish on the strengthening of the US dollar or the weakening of the Indian rupee.

· The maximum profit of this call spread is achieved at the higher strike at which the call is sold i.e. Rs.74 strike. As you can see, the maximum profit of 1.40 is achieved at the price level of 74 and after that the profits are flat. Whatever you gain on the 72 call is lost on the 74 call beyond this point.

· When should you sell the 74 call instead of the 73 call? That depends on your view of the upper limit for the dollar. You must notice one thing. You earn just 0.10 on selling the 74 call, which is making a very small impact on your overall cost. At the same time, the maximum profit is higher at 1.40 in this case. This is the trade-off that you will have to make. This is a good strategy when you are expecting the dollar to strengthen marginally or the rupee to weaken moderately.