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The call backspread (reverse call ratio spread) is a bullish strategy in options trading that involves selling a number of call options and buying more call options of the same underlying stock and expiration date at a higher strike price. It is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience significant upside movement in the near term.
|Call Backspread Construction|
|Sell 1 ITM Call
Buy 2 OTM Calls
A 2:1 call backspread can be implemented by selling a number of calls at a lower strike and buying twice the number of calls at a higher strike.
Unlimited Profit Potential
The call back spread profits when the stock price makes a strong move to the upside beyond the upper breakeven point. There is no limit to the maximum possible profit.
The formula for calculating profit is given below:
- Maximum Profit = Unlimited
- Profit Achieved When Price of Underlying >= 2 x Strike Price of Long Call – Strike Price of Short Call +/- Net Premium Paid/Received
- Profit = Price of Underlying – Strike Price of Long Call – Max Loss
Maximum loss for the call back spread is limited and is taken when the underlying stock price at expiration is at the strike price of the long calls purchased. At this price, both the long calls expire worthless while the short call expires in the money. Maximum loss is equal to the intrinsic value of the short call plus or minus any debit or credit taken when putting on the spread.
The formula for calculating maximum loss is given below:
- Max Loss = Strike Price of Long Call – Strike Price of Short Call +/- Net Premium Paid/Received + Commissions Paid
- Max Loss Occurs When Strike Price of Long Call
There are 2 break-even points for the call backspread position. The breakeven points can be calculated using the following formulae.
- Upper Breakeven Point = Strike Price of Long Call + Points of Maximum Loss
- Lower Breakeven Point = Strike Price of Short Call
Suppose XYZ stock is trading at $43 in June. An options trader executes a 2:1 call backspread by selling a JUL 40 call for $400 and buying two JUL 45 calls for $200 each. The net debit/credit taken to enter the trade is zero.
On expiration in July, if XYZ stock is trading at $45, both the JUL 45 calls expire worthless while the short JUL 40 call expires in the money with $500 in intrinsic value. Buying back this call to close the position will result in the maximum loss of $500 for the options trader.
If XYZ stock rallies and is trading at $50 on expiration in July, all the options will expire in the money. The short JUL 40 call is worth $1000 and needs to be bought back to close the position. Since the two JUL 45 call bought is now worth $500 each, their combined value of $1000 is just enough to offset the losses from the written call. Therefore, he achieves breakeven at $50.
Beyond $50 though, there will be no limit to the gains possible. For example, at $60, each long JUL 45 call will be worth $1500 while his single short JUL 40 call is only worth $2000, resulting in a profit of $1000.
If the stock price had dropped to $40 or below at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss.
Note: While we have covered the use of this strategy with reference to stock options, the call backspread is equally applicable using ETF options, index options as well as options on futures.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the call backspread in that they are also bullish strategies that have unlimited profit potential and limited risk.
Call Backspread Trade Explained
In the USA (United States of America) the short call ladder trade is popularly called as Call Backspread Trade. After my article on the short call ladder, I got an email from one of my regular website visitors, Mr. Michael from the US. We exchanged some questions and answers on this trade.
Call Backspread, I assume has a lot of interest to new option traders looking to make unlimited income by paying the least amount of money. We will soon know this is not the case.
Since the discussion was detailed and advanced I have kept this in a different article. This may be of interest to people looking for more information on the Call Backspread trade or the short call ladder.
If you are one of those traders who buy more OTM options and sell less number of near the money options to reduce cost as a single trade, knowingly or unknowingly you are trading the backspread. This discussion maybe of interest to you.
New traders who lost money buying naked options, think Call Backspread is a God send trade, a boon for cheap option buyers. They of course get disappointed.
Please note that the Call Backspread behaves the same way and produces similar results as the Put Backspread or the Short Put Ladder (if you are bearish). Needless to say please draw your own conclusion when you trade the Put Backspread or the Short Put Ladder.
What is a Call Backspread Trade?
In a Call Backspread trade the trader has a bullish view in the stock, but he/she is not willing to risk too much money by just buying costly ATM naked call options which may produce stellar returns if the view is correct. However if wrong, the trader knows he has a lot to lose. In fact the option may expire worthless, and all his money can be lost.
To reduce this risk he sells some in the money (ITM) calls and buys more number of ATM (at the money) or OTM (out of the money) call options. Essentially the trader feels that he will take the ride for free if the stock actually rises. In reality that is not the case.
(In the image above the trader has got a credit to do Call Backspread. See how the stock first has to travel through the loss zone to the profit zone. Only when a rally comes it goes into the profit zone. A trader may not have patience to wait that longer to take the “unlimited profits” lure this trade has.)
Most common trade is to sell 1 Call option and buy 2. Which means the trader sells 1 ITM option and buys 2 ATM/OTM options. This trade can result in a debit or a credit. If the options bought are further out of the money – the trade can be done on a credit.
But DO NOT think that if there is a credit the trader cannot lose money. There is always a trade off in these trades. In this discussion a lot of your doubts on Call Backspread will be cleared.
Lets gets started.
I just read through your E-book of the breakdown and discussion of the different options strategies. A fantastic and thorough explanation of the various option strategies.
I wanted to please ask you for your insight into trading Call and Put option “Backspreads” as these seem to be very directional type of strategy.
My thinking is, instead of doing a vertical debit spread, where upside profit is capped and also, buying regular long calls and puts for a directional trade, The Backspread seems ideal for this as:
1. You have the same flexibility in selecting strikes that fit your profit to risk threshold, but you get the added benefit with the Backspread over the Vertical, because your upside isn’t capped and you therefore have “unlimited profit potential”.
2. You can even make a credit, if the Backspread is initiated for one, if the trade goes below the sold Call for example, if doing a Bullish Backspread trade (it basically then becomes a Bear Call trade at that point).
3. You have the option of altering your ratio of bought to sold, depending on just how strongly you feel that the trade will make a big move.
4. On the high dollar priced, as well as volatile stocks like GOOG (Google Inc.), CMG (Chipotle Mexican Grill, Inc.), PCLN (Priceline Group Inc.), ICPT (Intercept Pharmaceuticals Inc.), BIIB (Biogen Idec Inc.), SPY (SPDR S&P 500 ETF Trust) – buying the outright calls and puts on these can be quite expensive, especially if buying 60 – 90 days out till expiration.
So by using a Backspread, we are in a sense doing a Vertical spread, of which we can play these higher dollar / more Volatile stocks at a discount.
I know that you are very knowledgeable about the strategies (Backspread) so just wanted to get your opinion on trading them, and if you had any thing specific, that I need to understand before implementing this strategy.
Thanks so much for your time and sharing your knowledge.
I really appreciate it.
P.S: How much and how would I go about purchasing your course please, as I live in the USA?
>> 1. You have the same flexibility in selecting strikes that fit your profit to risk threshold, but you get the added benefit with the Backspread over the Vertical, because your upside isn’t capped and you therefore have “unlimited profit potential”.
This is true. But where do you book profits? Be honest when you answer this question. In my view there are a few choices:
a) Leave till expiry. Not good choice for any option trade in the world. A profitable position may get into loss.
b) Set a target. Good but difficult as volatility will be a big player. Plus when the stock is moving up you will get greedy for more. Remember the money is there to take and its unlimited. You may want to ride this as much as possible only to see you got less than you wanted.
You will NEVER be satisfied with whatever you make especially if the stock finishes up further on the expiry day. Still setting a target is a good idea. Buy you should exit once its reached and not look back at the trade.
c) As soon as ATM/OTM bought options becomes ITM. (Not sure if at that time the trade is profitable.) This will be tricky as at that time the trade may be in profit or loss. So even this choice is not good.
That leaves us with (b) – set a target and exit. But this target has to be with losses as well. If you read my article on short call ladder you will see that maximum loss is unbearable. You have to make sure it does not happen. So you have no option but to set a target.
Now tell me what is the difference between this trade and buying less number of naked ATM call options? You can always set a target even when you buy an option and exit for a set profit or a loss. Agreed if the stock falls below the shorted option and if the Call Backspread was done for a credit the trader may make a small profit.
But to create such a trade you will have to buy options far out of the money. For option buyers this is not recommended because realizing a good profit when the stock rallies will get difficult. You may therefore most of the times trade this with a debit. So you lose money even if the stock falls.
Moreover the stock will not fall every time you trade. Therefore to me this is not a better trade than a simple Call Debit Spread. If my view is bullish, I would rather trade a Debit Spread than a Call Backspread for the simple reason that risk in a debit spread is far better than a Call Backspread. Reward may be better in a backspread trade, but for me risk is more important than reward. Call Backspread only looks better on paper – in reality it is not.
So would always entering a Backspread trade, be best by entering with 1 sold ITM and buying 3 – 4 OTM, for the sole purpose of being able to take profits once certain targets are hit, and still having the trade covered via having more bought Calls then sold Calls?
I know that by doing so, that we likely wouldn’t receive a credit for putting on the trade (and may be even a small Debit), but by using a 3-4 bought for 1 sold, we give ourselves the opportunity to lock in and take profits, if and when the trade exceeds the upper Breakeven?
As long as you are getting a credit – or trading with a small debit – this is OK. But remember doing this with great strike prices may be difficult. You may have to go deep ITM sell and deep OTM buy – not good.
Also you need to calculate max loss – this is the place where the stock expires where all the options bought expires worthless and you also need to pay money to cover the short. This situation will be worse than buying naked call options. This means even if you have a credit, it does not mean you cannot lose money.
>> 2. You can even make a credit, if the Backspread is initiated for one, if the trade goes below the sold Call for example, if doing a Bullish Backspread trade (it basically then becomes a Bear Call trade at that point)
This is true but you may have to buy deep OTM calls. In that case even if the stock moves in correct direction your target may get difficult to achieve.
Great point, and I guess this also gets back to the last question, to be able to buy at a higher ratio of long calls to short ( 3 – 4 : 1 ), we’d likely have to buy further OTM or sell deeper ITM, to cover the extra 1 to 2 Long calls.
Would it then come down to, whether or not we are fine with NOT receiving a credit for initiating the Trade?
The problem with such a trade is that the stock has to move significantly for the deep OTM calls to make meaningful gains. Remember that the delta of the short is more than the delta of longs. So one the one hand your short will be loosing money fast, one the other the bought Calls will make money slowly.
However try to trade the best options possible and make sure you are NOT paying a lot of cash to trade this. Small debit is OK.
>>It seems that, we would put on a BackSpread trade, if we had a strong conviction, that the stock was going to make a BIG move.
So my thinking is, would it make sense then, to put on more Long calls and thus give up receiving a credit, to allow ourselves the opportunity to have on the extra 1 or 2 long calls, to lock in profits along the way, if/as the trade makes that BIG move we were expecting?
Yes true – but how many times will this happen? Do you think every time you expect a big move – the stock will actually move that big? If not your cash will be lost. Over time this will neutralize the results. Sometimes great – sometimes not so great. Consistency will be lacking.
>> 3. You have the option of altering your Ratio of bought to sold, depending on just how strongly you feel that the trade will make a Big move.
Yes true – keep changing your view and keep losing money when you were too bullish. And make less when you were less bullish. Markets won’t behave the way you want them too.
>> 4. On the high dollar priced, as well as volatile stocks like GOOG, CMG, PCLN, ICPT, BIIB, SPY buying the outright calls and puts on these can be quite expensive, especially if buying 60 – 90 days out till expiration. So by using a Backspread, we are in a sense doing a Vertical spread, of which we can play these higher dollar or more Volatile stocks at a discount.
Options are priced in such a way that doing Backspread for 60-90 days options will surely cost you money. Its not easy to go that far, get great strike prices, and still get a credit.
>>So the BackSpread then works like buying a regular Long and Put works. The more time to Expiration, the more expensive the Options.
Now at last, Thank God you understood.
>> How many days to Expiration then, do you usually look to go out, as to allow yourself enough time for the trade to make the move you are expecting – 30, 45, 60, 75, 90 days?
See in this trade you are mostly long calls. Going very far or short in number of days is NOT important. Your view on the stock and Max loss that you may face is. Please calculate your max loss when trading this. Agreed if you stop out earlier, you will not lose the max loss – but its an important number to know before you trade. This is the reason why you shouldn’t pay a lot to trade this. Small debit is OK. That way if the stock falls, you don’t lose much.
>> And does the time to Expiration come into play, depending on what time frame chart you are basing the trade itself on?
For instance, on a 1 Day chart, may be buy 30 – 45 days till Exp.
On a Weekly chart, go with around 60 days till Exp.
On a Monthly chart, 75 – 90 days?
As I said – plan before you trade. See if your Max loss (unfortunately profit cannot be calculated) justifies the trade. If there is a Max loss you are NOT comfortable with – either you should not trade or you should have a stop loss in your system. For profit taking too – you should know how much profit you want from the trade. Unlimited is only on paper, until you take it.
I think in US you can have a stop loss in system which is called Good ‘Til Canceled (GTC). This feature is not here in India. Make best use of GTC. Or monitor your trades closely to take profit/loss out at a predetermined value.
Remember this – you basically want to make unlimited profits, by paying the least. The idea is right, the implementation difficult. My only problem is unlimited profits is on paper. When the stock moves in your direction depending on how many options you bought and sold you may be making less because of the losses in the sold option, and you may want to wait.
Usually this will bring good profits when expiry is near. You may want to wait for expiry and then the stock reverses. In panic you may stop out earlier. You cannot time this as the way you think you can.
Another very important point is Backspreads usually makes profit after traveling from the negative zone to the positive. Read this article to know more on this:
Michael, Many Thanks for asking some genuine questions on Call Backspread. This will help a lot of traders.
Call Ratio Backspread Definition
What Is a Call Ratio Backspread?
A call ratio backspread is an option strategy that bullish investors use if they believe the underlying security or stock will rise by a significant amount.
The strategy combines the purchases and sales of options to create a spread with limited loss potential and mixed profit potential. However, gains can be significant if the underlying financial instrument rallies.
How to Formulate a Call Ratio Backspread
A call ratio backspread is generally created by selling, or writing, one call option and then using the collected premium to purchase a greater number of call options with the same expiration at a higher strike price. This strategy has potentially unlimited upside profit because the trader is holding more long call options than short ones.
For review, a call option gives the option buyer the right, but not the obligation, to buy a stock at a specified price within a specific time period. If an investor buys a call option with a strike price of $10 while the stock is trading at $10, the option is considered at-the-money. If the stock rises to $15, the call option makes money. If the underlying stock falls to $5, the investor loses only the premium paid for the call option and never owns the stock.
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The call ratio backspread allows an investor to buy call options on a stock that is out-of-the-money meaning the option strike price is higher than the current stock price. So, if a stock was trading $15 in the market, an investor might buy call options with a $17 strike price and pays a premium for the options. The investor could also buy the call options at-the-money meaning the strike price of the options is equal to the current market price of the stock.
In order to finance the premium for purchasing the call options, the investor sells a call option that’s in-the-money or below the current stock price. So an investor might sell one call option at a strike price of $13 while the current price of the stock trades at $15 in the market. By selling the call option, the investor gets paid a credit for the premium of the option. The credit offsets the premium paid for buying the call options at the $17 strike price. The offset in premiums could be a partial offset or the credit received could exceed the premium paid for the call options. The premiums charged depend on many factors including the volatility of the stock price.
What Does a Call Ratio Backspread Tell You?
Backspread strategies are designed to benefit from trend reversals or significant changes or moves in the market. Call ratio backspread strategies are part of a category of options trading called ratio strategies.
The goal of the strategy is to own call options on a stock because the investor believes the stock will go above the strike price of the purchased call options. Ideally, the price needs to go high enough to compensate for any premium paid for the call options. However, the sale of the option that’s in-the-money is placed to pay the investor a credit to offset or finance the purchase of the call options.
Using the numbers earlier, the investor would want the stock price to rise from $15 to well above the $17 (the strike price for the call options) and earn enough to more than pay for any premium for purchasing the call options.
An investor using a call ratio backspread investing strategy would sell fewer calls at a low strike price and buy more calls at a high strike price. The most common ratios used in this strategy are one in-the-money short call combined with two out-of-the-money long calls or two out-of-the-money short calls combined with three in-the-money long calls. If this strategy is established at a credit, the trader stands to make a small gain if the price of the underlying security decreases dramatically.
Call ratio back spread strategies are designed to benefit from increases in market volatility. Investors typically employ them when they believe financial markets are poised to move higher. By simultaneously buying and selling call options, traders can hedge their downside risk, while benefiting from the upside as markets gain. Backspread strategies can be used on a standalone basis, to “go long” the market. Alternatively, they can be used as part of a larger or more complex investing position.
Options traders can deploy directional strategies such as ratio strategies to reflect either bullish or bearish views on the market. If that view is negative, there is a similar strategy to the call ratio backspread that is designed to benefit from falling markets. Known as put backspread strategies, these involve buying and selling combinations of put options rather than call options.Takeaways
- The call ratio backspread is an option strategy that bullish investors use if they believe the underlying security or stock will rise by a significant amount.
- The strategy combines the purchases and sales of options to create a spread with limited loss potential and mixed profit potential. However, gains can be significant if the underlying financial instrument rallies.
- The stock price has to move high enough whereby you make enough money on the two at-the-money call options you purchased combined with the initial credit to more than offset any loss from the one in-the-money option that you initially sold.
Example of a Call Ratio Backspread
The example below does not factor any commissions from a broker, which need to be considered before executing any strategy. Let’s say you’re an investor who’s bullish on the stock of XYZ Company and you believe the stock could rise significantly in the short term.
- XYZ Company stock is trading at $20 per share in the market currently.
- Call options with a strike price of $20 (at-the-money) currently trade with a premium of $2 each. You buy two option contracts whereby each contract is 100 options for a cost of $400 in total.
- The second leg of the strategy involves you selling one in-the-money call option. Call options for a strike price of $16 are currently trading at $6 each. You sell one call option at a strike price of $16 and receive a credit for $600 to your account.
- You have a net credit of $200 for the strategy initially because you paid $400 for buying the two at-the-money call options while you received $600 for selling the one in-the-money option.
- If the stock rises to $22 by expiry, you earn $2 on the two call options you purchased for a total of $400 (or 2 contracts at 100 options each multiplied by $2).
- However, the call option you sold will get exercised, and you’ll sell the stock at $16 while the market is at $22 for a $6 loss. The $6 is multiplied by 100 contracts (the one call option) yielding a $600 loss.
- Your net is the $600 loss minus the $400 you earned plus the $200 credit that you received initially for a gain of zero or breakeven.
In the above example, the stock price has to move high enough whereby you make enough money on the two at-the-money call options combined with the initial credit to more than offset any loss from the one in-the-money option that you initially sold.
Let’s say in the example; the stock moved to $26 by expiry.
- You would earn $6 on the two call options for a total of $1,200 (200 multiplied by $6).
- The call option that you sold would have a loss of $10 ($16 strike – $26) or $1,000 because $6 multiplied by the 100 contracts would yield a loss of $1,000 for the one option sold.
- However, your net gain would be $400 because your $1,000 loss is subtracted from your $1,200 gain on the two options purchased plus the $200 earned from the initial credit.
Let’s say in the example; the stock moved to $10 by expiry.
- The two options that you bought would expire worthless since you wouldn’t exercise the option to buy at $20 when the price is trading at $10 in the market.
- Similarly, the call option that you sold would not get exercised because no one would buy at $16 if they can buy the stock at $10 in the market.
- In short, you would earn the initial credit of $200 and both options would expire worthless.
What’s the Difference Between the Call Ratio Backspread and the Put Ratio Backspread?
A put ratio backspread is an options trading strategy that combines short puts and long puts to create a position whose profit and loss potential depends on the ratio of these puts. A put ratio backspread is so called because it seeks to profit from the volatility of the underlying stock, and combines short and long puts in a certain ratio at the discretion of the options investor.
The put ratio spread is similar to call ratio spread, but instead of buying two call options and selling one call option to finance the strategy, you would buy two put options and sell one put option to help finance the purchase of the two puts.
If the stock goes down by a significant amount, the strategy earns money from the two puts to offset any loss from the one put that was sold.
Limitations of Using the Call Ratio Backspread
As with any trading strategy, there is always the risk of loss due to market conditions or excessive volatility. It’s best to contact your broker to get options training before initiating any strategy. Your broker should also have the ability to run test strategies in a mock account so you can get some experience before using real money.
Call Backspread Reverse Call Ratio Spread Explained
Another bullish strategy is the call backspread a.k.a reverse call ratio spread. This strategy has unlimited profits with limited loss. As again and I have told this many times in my blog that unlimited profits or unlimited losses are only on paper. You can always take a stop loss or hedge your position.
BTW, I always hedge my positions and get out whenever I feel I have made a decent profits or loss. What about you?
Call backspread or reverse call ratio spread is good strategy for a volatile market when a stock moves in any direction. But you profit more if it moves up. If it falls you keep the premium received.
The Call BackSpread strategy Explained:
In a call backspread the trader will sell one ITM (in the money) call and buy double or more number of OTM (out of the money calls). Some people say you should only buy double the number of call options sold, but the fact is you should buy more calls than the number of calls sold and this depends on what is your view of the market. If you are absolutely sure markets will move up – buy more than double the number of calls. But on the other side it will increase risk because the premium received will be less than the money needed to buy calls. In that case if the stock falls, you may suffer losses.
Now this “more” depends on how much you are willing to risk. Ok let me explain in details.
The Call BackSpread strategy example:
Let us suppose Nifty is at 5500 and you are bullish. You can sell one ITM call and buy two OTM calls.
Sell one lot of 5400 call @ 200.
Buy two lots of 5700 call @ 50.
Sell one lot of 5400 call @ 200 = 200 * 50 * 1 = Rs. 10,000.00 (Credit)
Buy two lots of 5700 call @ 50 = 50 * 50 * 2 = Rs. 5,000.00 (Debit)
Total amount credited: 10,000.00 – 5,000.00 = Rs. 5,000.00 credit to the traders account.
Note that the trader to reduce risk can always buy calls with lower strikes, for example 5600 call. But then the credit they receive will also get smaller. If they come even close letâ€™s say buy the 5600 call, the risk gets even less, but then the account gets debited (not credited) and if Nifty does not move much or even closes lower, the trader losses money.
So ideally you should go that far to buy calls that make sense. Same is the case with selling calls. You got to be sure that the premium you receive is something you are comfortable with. Selling OTM calls and buying deep OTM calls will be useless. The premium you receive is also important.
There is another twist to this strategy. If you do this with really very deep in the money calls and get a good premium, you would want Nifty to fall and expire somewhere near the strike price of the sold call – because in that case you will be happy to keep the premium.
This is in total contrast to what this strategy stands for – a bullish strategy. But then why people don’t trade this with deep in the money calls? Because the losses can be heavy if Nifty expires somewhere in between the bought call strike price and the sold call strike price. The trader in that case loses the money they used to buy the ITM calls and also may suffer losses in the sold call. That’s a worst case situation and as you know, no one can predict Nifty movements.
You must be thinking why the trader will lose money in both the call sold and the one bought. Ok letâ€™s look at the results to clear this confusion.
Situation 1) Worst case: Nifty expires exactly at 5700:
Loss from the 5400 call sold @ 200: 5700-5400 = 300. (200-300) * 50 = -5000.
Loss from 5700 call bought @ 50: 5700 calls expires worthless. Money the trader used to buy these calls is now 0. A loss of 50 * 50 * 2 = -5000.
Total loss = -5000 + -5000 = Rs. -10,000.00.
I hope now the confusion is cleared. The trader losses money in both the sold calls and the bought ones. However the good news is that this is the maximum he will lose. The trader cannot lose more than that.
Tip: Whenever you trade options you should have a bail out point. Even before you start trading you should know what’s the Max loss you will take in the trade. Once it is reached just exit the trade and do not look back. Move to next trade. Trading is all about risk management, not about making money. If you are trading to make money eventually you will lose.
Situation 2) Average case: The view was wrong Nifty expires below 5400:
Loss from 5700 call bought @ 50: 5700 calls expires worthless. Money the trader used to buy these calls is now 0. A loss of 50 * 50 * 2 = -5,000.00.
Profit from the 5400 call sold @ 200: 5400 call expires worthless. The trader keeps the premium. 200*50 = Rs. 10,000.00
Total Profit: 10,000.00 – 5,000.00 = Rs. 5,000.00.
Situation 3) Best case: The view was right Nifty expires at 6000:
Profit from the 5700 calls bought @ 50: 6000-5700 = 300 – 50 = 250 * 50 * 2 = 25,000.00
Loss from the 5400 call sold @ 200: 6000 – 5400 = 600 – 200 = 400 * 50 = 20,000.00
Total Profit: 25,000.00 – 20,000.00 = Rs. 5000.00
Note that Call BackSpread is an unlimited profit strategy. If Nifty closed at 6100 profits would have increased.
(350*50*2) + (-500*50) = 35000 – 25000 = Rs. 10,000.00
As you can see from the above the trader suffers losses only if Nifty expires anywhere near the strike price of the calls bought. Now my question is will a trader actually wait till the expiry?
He will have a target in mind. If he is making a profit he should close the position and exit or if his stop loss is hit, again close the position. It is never a good idea to wait until expiry for any option bought or sold.
I have given the results as per the expiry because it is very difficult to know exactly what prices the options will be when they have not expired as it depends a lot on volatility, time and other factors. It will not be fair on my part to assume the prices and explain the results.
What happens if a trader buys the same number of lots and sells the same number of lots? In that case it becomes a call credit spread (and not call backspread) strategy in which a trader wants the indices to stay below the strike price of the calls sold. If the stock or the index moves north, the trader loses money. But in the backspread they make money if the index moves north.
So which one is a better strategy? The call credit spread or the call backspread. It depends on the situation. If you think there is big news coming and Nifty may move up, but the lack of news or negative news may take it down – you should implement the call backspread strategy.
Another Tip: Once the news is in and your view was right and Nifty starts to move up, you can buy more ATM or slightly OTM calls up to a level of risk you can take. But if the opposite happens, just convert it to a call credit spread by selling more ITM calls.
You can go for a call credit spread when you are sure index will not move up – i.e. stay where it is or move south.
If you have any confusion you can ask in the comments section.
Call Ratio Backspread Option Strategy Explained
Call ratio backspread strategy for big bull Moves
Call backspread Options strategy Explanation
This strategy is adopted by traders who are bullish in nature. Learn more about bullish options trading strategies here. If you expects market and volatility to rise in the near future.
A trader need not be direction specific here (i.e. an upward or downward trend, but a small bias towards an uptrend should always be present, as the gains will be much higher once the market moves up rather than market moving down and keeping premium as income. Learn how to generate monthly income with the help of covered call options strategy.
This strategy involves buying of 2 OTM Call Options and selling 1 ITM Call Option. The strategy combines the purchases and sales of options to create a spread with limited loss potential and mixed profit potential. This is a volatile options trading strategy that primarily profits when the underlying security makes a big upward price movement. Traders can use this strategy mainly for banknifty options or high volatile stock options like yes bank, DHFL, etc.
Call backspread Options strategy Risk analysis
Call backspread Options strategy Construction
Sell 1 ITM Call Option
Buy 2 OTM Call Options
Call backspread Options strategy Payoff Chart
Call backspread Options strategy Examples
Suppose BANKNIFTY is trading around 29600 levels, and you are bullish on the market and the volatility. So you will apply Call ratio Backspread Strategy.
You will sell one 29000 BANKNIFTY ITM Call Option for a premium of Rs. 650 & buys two 30000 BANKNIFTY OTM Call Options at a premium of Rs. 60 each. BANKNIFTY options lot size is 20 quantity. Learn more about how to trade Nifty Banknifty F&O.
So Now in this strategy your net investment will be Rs. 0/-. Let see how you sold 29k options 650 and brought 30k 2 call options at 60 each means your next premium will be 650-120=53 rupees which you will receive it. Which will be 10600 rupees. Learn how to make profit with Long Combo Option strategy.
Call backspread Options strategy outcome study
Call backspread outcome 1: At expiry if BANKNIFTY closes at 31000, then you will make a profit of Rs. /-. Let see how, first at 31k level your 29000 call options will be trading around 1400 rupees means you make loss of almost 750 rupees premium on that positions. And you 30000 call options will be trading around 1000 rupees each means you make 1880 rupees premium profit here. You net premium will be 1880-750 means 1130 rupees premium profit means Rs. 1130 * 20 = 22600/-rupees profit.
Call backspread outcome 2: At expiry if BANKNIFTY closes at 29000, then you will keep the premium amount received from sale of 29000 BANKNIFTY ITM Call Option. Your net gain will be Rs. 10600/-.
Call backspread outcome 3: At expiry if BANKNIFTY closes at 30000, then you will make a loss of Rs. 9000/-. At 30k, you 30K OTM option expires worthless and you will make 450 rupees loss of 29000 ITM call options short means 450 *20 = 9000 rupees loss.
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