The bull spread is described as a reliable investment strategy whose goal is to help an investor realize profit resulting from an increase in the price of given security according to Bull spread (Madura 2010). It is created by choosing to purchase at times of low price and then selling at times when the prices have considerably risen. According to (Becker 2010) like any other currency combination strategy, the success reached in a bull spread is entirely dependent on timing.
An investorâs strategy to identify and purchase the right combination, and hold on till that time when the price is just about to or perhaps has just begun to fall determines how much profits are to be realized. There arises a problem of market trend analysis. This problem highlights the necessity of a guide in the bull spread strategy. On basis of previous attempts of the same goal, I seek to develop a more informed solution to the currency bull spread strategy in this paper.
To arrive to a reliable solution in my exercise, I took time to understand the bull spread strategy. Thereafter, I took a few sample situations and observed the changes in time and price. From my observations, I created a pattern of currency combinations. I used this pattern to draw my conclusion which leads us to a possible solution in bull spread strategy. I have therefore arranged this paper in systematic sessions as described above to help us follow in reaching the solution. The first is an account on a bull spread. Secondly, we take a situational example of a real-life setting where we make observations of arising patterns. Lastly, we use the pattern drawn to conclude and probably design a solution to currency bull spread.
About Bull Spread
As described earlier, bull spread is a reliable investment strategy whose goal is to help an investor realize profit resulting from an increase in the price of given security according to Bull spread (Leroux 2010). This exercise involves either puts or calls. A call in this case refers to the right to purchase a security at a given price on or by a specific date. A put on the other hand is the right to sell a security at a specific price on or by a specific date (Ebert 2010).
The naked long call is one of the simplest bull strategies. It involves buying a call less any form of hedge. This strategy is used mostly used in the thought that the price of a security is going to shoot up. The other strategy is the bull spread. The bull spread, like the naked long call, also operates in consideration of expected highs in the security price. It is less risky. However (McMillan 2010) says, it is a reward limiting strategy when the stock is relatively too high. We have noted so far that the challenges in the bull spread are timing. It is difficult to know when to hold on, when to call or when to put. It is also difficult and inevitably necessary to foresee a âreward limiting situationâ and be able to evade it. Through a simple situational example, we can find a solution to these otherwise never-ending difficulties.
Consider;A situational bull spread example. Suppose a market with two call options in US dollars. (US$) available. The strike price of one of the options has a strike price of $.51.2 and a premium of $015.2. The strike price of the other option is $52 and a premium of $.012. A bull spreader buys the $.51.2 option and sells the $.52 option. An option contract on US dollars amounts to 40,000 units in this case.
Appreciation of the US dollar to $.51.6. The bull spreader gains a profit for selling the US dollars at $51.6 having bought them at $.51.2. He also collects a premium on the second option previously written although he/she will not exercise that option.
Note that the bull spreader would have incurred a loss had he purchased the first option only.
The US dollar appreciates to $.56. The bull spreader here will exercise the option he purchased but the option he wrote is exercised by an unknown buyer as well. If he sells the USD bought with the first option and buys the USD, then he needs to sell the second option buyer at the spot rate. Below is a summary of his cash flow.
One clear observation and point to understand is that the bull spreader here is limited to a net profit of $004.8 however high the value of the USD reaches. This is a result of a âcancel out effectâ as described by (Jeff 2009). Secondly, out off the bull spread trade off, the bull spreader can not enjoy any opportunity costs.
The USD depreciates to $.49.6. Notice here that neither calls options will be exercised as both are out of cash. In this case, the spreader’s net profit is as shown below.
From the data of example given above, it is possible to construct a worksheet and a graph.
Worksheet
Value of USD at option expiration
Below is the corresponding contingency graph.
Future spot rate
From the worksheet and contingency graph above, maximum loss is bounded between the two option premiums. Also, the profits are limited to the difference in strike prices. The break even point is the lower exercise price summed up with the difference in the two option premiums.
As mentioned earlier, it is easy to construct a currency bull spread with put option just like with call option. The basic calculations involved in both exercises follow the same principles as explained in (McMillan 2010) work.
Conclusion. (Ziegler 2008) says that success in currency bull spread is depended on individual expertise in timing correct decision making. This expertise is not inborn, it is only learnt. Therefore, with critical analysis of currency combination data, we can reach a conclusion. Basically, the conclusion drawn are the answers we seek in regards to timing and correct decision making in this field of currency bull spread.
Works cited
Becker. âCurrency Trading.â Online Forex. New York Times. 2010. Web.
Ebert M. âStocks.â Investment matters. Print. 2008.
Leroux. âBullish strategies.â The options guide journal 67 ( 2010) : 33-37. Print.
Madura, J. âInternational Financial Management.â South Western CENGAGE, 9th Edition: 154-166. Web. 2010.
McMillan, Lawrence G. âOptions as a Strategic Investment.â New York Institute of Finance. New York. Web. 2010.
Ziegler.âMarket Watch.â The Wall Street Journal 18 (2009) : 64-68. Web.