Option Buying Strategy for This Bottom Reversal Stock!

When picking up stocks that have taken a severe beating in the recent past one needs to be careful. Generally, fundamentally strong companies make a good candidate for the buy-on-dip strategy as the chances of investors’ demand coming back on track are high for such companies.

One such robust business that is down around 23% in the last one year and is now looking for mean reversion is Jubilant Foodworks Limited (NS: JUBI ). It is a franchise owner of Domino’s Pizza, Dunkin’ Donuts etc in India and has a market capitalization of INR 27,801 crores. After falling sharply, the stock noticeably slowed its further fall since mid-February 2023 which is a good indication of increasing investors’ inclination toward this counter.

Although a very sharp upside might not be possible yet, investors can still witness a decent rally to INR 450 by the current April 2023 expiry, from the CMP of INR 435.15 (as of Thursday). The bullish view can simply be traded by going long on the underlying, for which a stop loss below INR 420 (spot) seems sufficient, giving the whole trade a 1:1 risk-to-reward ratio.

However, options traders can also look at initiating a bull call spread to further skew this ratio in their favor. The current 435 CE (ATM ) is trading at INR 9.7 and the 450 CE (OTM) is trading at INR 4.2. The bull call spread is made by buying a lower strike and selling the higher strike which in this case is long 435 CE and short 450 CE.

The net premium paid for this strategy is INR 5.5 per lot and this is the max risk on the trade. On the upside, the max reward will come if the stock closes at/above INR 450 on the expiry day and there the profit would be INR 9.5 per lot. Here you can see the risk-to-reward ratio has been improved, from earlier 1:1 to 1:1.7. More importantly, this strategy has a fixed max loss no matter how strong the stock crashes from here, which is not the case with a simple long stock or futures.

This strategy will give profits if the stock closes above 440.5 by the expiry, which is breakeven. However, keeping the strategy till expiry is not recommended due to the physical delivery risk and excessive margin requirements. Try to square off any stock options position 1 day before the expiry day irrespective of profit or loss.

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