Call Ratio Back Spread
Description
The Call Ratio Backspread is an exciting
strategy that enables you to make accelerated profits provided that the stock
moves sharply upwards or downwards. It is a volatile options strategy. It has unlimited
upside potential, and limited downside potential for profit. The strategy is
used when you are very bullish about the potential movement of an instrument or
market.
The worst thing that can happen is that the
stock does not move at all, because then you lose money.
The Call Ratio Backspread involves buying
and selling different numbers of the same expiration calls. Typically you buy
and sell calls in a ratio of 2:1 or 3:2, so you are always a net buyer. This
gives you an uncapped profit potential. It also reduces the net cost of doing
the deal such that you can even create a net credit!
Market Opinion
Aggressively bullish.
P/L
Profile
When
To Use
If
the investor is convinced there is potential for a strong upward movement in
the underlying stock price, increasing volatility, and is confident of the
ability to successfully execute this kind of trade, then this is the
appropriate option to use.
Example
A
2:1 Ratio: May 9, 2011 XXXX is trading t $25.00. Sell one January 2012 25
strike call at $4.90. Buy two January 2012 30 strike calls at $2.50.
A
3:2 Ratio: Or, sell two January 2012 25 strike calls at $4.90. Buy three
January 2012 30 strike calls at $2.50.
Benefit
In
the first case (2:1 Ratio), the benefit is unlimited upside with only the
difference in the strikes plus net debit.
In
the second case (3:2 Ratio), also unlimited upside with a only a downside of
the number of short calls times difference in strikes minus net credit.
Risk
vs. Reward
Maximum
risk: Difference in strike prices minus net credit received or plus net deb
paid. The reward is unlimited.
Net
Upside
The
cost of the trade is reduced. Downside risk is limited. Unlimited reward if the
stock moves up.
Net
Downside
Risk
increases if the stock does not move. Another downside is that this is a
difficult trade to maneuver.
Break
Even Point
Lower
strike price plus net credit.
Effect
Of Volatility
Positive
if stock prices is moving upwards. The greater the volatility upwards, the
better.
Effect
Of Time Decay
Negative
impact. The longer you have to realize a big move, the better.
Alternatives
Before Expiration
Investors
can partially close out the position as the stock moves up and down.
Alternatives
After Expiration
Close
the position by buying back the calls sold and selling the calls bought.
