Call Backspread Explained

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Call Spreads

A call spread is an option spread strategy that is created when equal number of call options are bought and sold simultaneously. Unlike the call buying strategy which have unlimited profit potential, the maximum profit generated by call spreads are limited but they are also, however, comparatively cheaper to implement. Additionally, unlike the outright purchase of call options which can only be employed by bullish investors, call spreads can be constructed to profit from a bull, bear or neutral market.

Vertical Call Spread

One of the most basic spread strategies to implement in options trading is the vertical spread. A vertical call spread is created when the short calls and the long calls have the same expiration date but different strike prices. Vertical call spreads can be bullish or bearish.

Bull Vertical Call Spread

The vertical bull call spread, or simply bull call spread, is used when the option trader thinks that the underlying security’s price will rise before the call options expire.

Bear Vertical Call Spread

The vertical bear call spread, or simply bear call spread, is employed by the option trader who believes that the price of the underlying security will fall before the call options expire.

Calendar (Horizontal) Call Spread

A calendar call spread is created when long term call options are bought and near term call options with the same strike price are sold. Depending on the near term outlook, either the neutral calendar call spread or the bull calendar call spread can be employed.

Neutral Calendar Call Spread

When the option trader’s near term outlook on the underlying is neutral, a neutral calendar call spread can be implemented using at-the-money call options to construct the spread. The main objective of the neutral calendar call spread strategy is to profit from the rapid time decay of the near term options.

Bull Calendar Call Spread

Investors employing the bull calendar call spread are bullish on the underlying on the long term and are selling the near term calls with the intention of riding the long term calls for a discount and sometimes even for free. Out-of-the-money call options are used to construct the bull calendar call spread.

Diagonal Call Spread

A diagonal call spread is created when long term call options are bought and near term call options with a higher strike price are sold. The diagonal call spread is actually very similar to the bull calendar call spread. The main difference is that the near term outlook of the diagonal call spread is slightly more bullish.

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Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker!
    Perfect Choice For Beginners and Middle-Level Traders!
    Free Demo Account! Free Education!

  • Binomo
    Binomo

    Honest broker!

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Ratio Spread

What Is a Ratio Spread?

A ratio spread is a neutral options strategy in which an investor simultaneously holds an unequal number of long and short or written options. The name comes from the structure of the trade where the number of short positions to long positions has a specific ratio. The most common ratio is two to one, where there are twice as many short positions as long.

Conceptually, this is similar to a spread strategy in that there are short and long positions of the same options type (put or call) on the same underlying asset. The difference is that the ratio is not one to one.

Key Takeaways

  • A ratio spread involves buying a call or put option that is ATM or OTM, and then selling two (or more) of the same option further OTM.
  • Buying and selling calls in this structure is referred to as a call ratio spread.
  • Buying and selling puts in this structure is referred to as a put ratio spread.
  • There is a high risk if the price moves outside the strike price of the sold options, while the maximum profit is the difference in strikes plus the net credit received.

Understanding the Ratio Spread

Traders use a ratio strategy when they believe the price of the underlying asset won’t move much, although depending on the type of ratio spread trade used the trader may be slightly bullish or bearish.

If the trader is slightly bearish they will use a put ratio spread. If they are slightly bullish, they will use a call ratio spread. The ratio is typically two written options for each long option, although a trader could alter this ratio.

A call ratio spread involves buying one at-the-money (ATM) or out-of-the-money (OTM) call option, while also selling/writing two call options that are further OTM (higher strike).

A put ratio spread is buying one ATM or OTM put option, while also writing two further options that are further OTM (lower strike).

The max profit for the trade is the difference between the long and short strike prices, plus the net credit received (if any).

The drawback is that the potential for loss is theoretically unlimited. In a regular spread trade (bull call or bear put, for example), the long options match up with the short options so that a large move in the price of the underlying cannot create a large loss. However, in a ratio spread, there can be two or more times as many short positions as long positions. The long positions can only match with a portion of the short positions leaving the trader with naked or uncovered options for the rest.

For the call ratio spread, a loss occurs if the price makes a large move to the upside, because the trader has sold more positions than they have long.

For a put ratio spread, a loss occurs if the price makes a large move to the downside, once again because the trader has sold more than they are long.

Example of a Ratio Spread Trade in Apple Inc.

Imagine that a trader is interested in placing a call ratio spread on Apple Inc. (AAPL) because they believe the price will stay flat or only marginally rise. The stock is trading at $207 and they decide to use options that expire in two months.

They buy one call with a $210 strike price for $6.25, or $625 ($6.25 x 100 shares).

They sell two calls with a strike price of $215 for $4.35, or $870 ($4.35 x 200 shares).

This gives the trader a net credit of $245. This is their profit if the stock drops or stays below $210, since all the options will expire worthless.

If the stock is trading between $210 and $215 when the options expire, the trader will have a profit on the option position plus the credit.

For example, if the stock is trading at $213, the bought call will be worth $3, or $300, plus the $245 credit (because the sold calls expire worthless), for a profit of $545. The max profit occurs if the stock is at $215.

If the stock rises above $215, the trader is facing a potential loss.

Assume the price of Apple is $225 at the option’s expiry.

  • The bought call is worth $15 or $150 ($225 – $210 x 100 shares)
  • The two sold calls are losing $10 each or $200 ($225 – $215 x 200 shares)
  • The trader still has a credit of $245.

In this case, the trader will walk away with a small profit of $195.

If the price goes to $250, the trader is facing a loss.

  • The bought call is worth $40 or $400 ($250 -$210 x 100 shares)
  • The two sold calls are losing $35 each or $700 ($250 – $215 x 200 shares)
  • The trader still has a credit of $245.

The trader now faces a loss of $55, which will get larger the higher the stock price of Apple goes.

Vertical Spreads

The vertical spread is an option spread strategy whereby the option trader purchases a certain number of options and simultaneously sell an equal number of options of the same class, same underlying security, same expiration date, but at a different strike price.

Vertical spreads limit the risk involved in the options trade but at the same time they reduce the profit potential. They can be created with either all calls or all puts, and can be bullish or bearish.

Bull Vertical Spreads

Bull vertical spreads are employed when the option trader is bullish on the underlying security and hence, they are designed to profit from a rise in the price of the underlying asset. They can be constructed using calls or puts and are known as bull call spread and bull put spread respectively.

While they have similar risk/reward profiles, the bull call spread is entered on a debit while the bull put spread can be established on a credit. Hence, the bull call spread is also called a vertical debit spread while the bull put spread is sometimes referred to as a vertical credit spread.

Bear Vertical Spreads

Vertical spread option strategies are also available for the option trader who is bearish on the underlying security. Bear vertical spreads are designed to profit from a drop in the price of the underlying asset. They can be constructed using calls or puts and are known as bear call spread and bear put spread respectively.

While they have similar risk/reward profiles, the bear call spread is entered on a credit while the bear put spread can be established on a debit. Hence, the bear call spread is also called a vertical credit spread while the bear put spread is sometimes referred to as a vertical debit spread.

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Continue Reading.

Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]

What are Binary Options and How to Trade Them?

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®. [Read on. ]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date. [Read on. ]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date. [Read on. ]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker!
    Perfect Choice For Beginners and Middle-Level Traders!
    Free Demo Account! Free Education!

  • Binomo
    Binomo

    Honest broker!

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