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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

 

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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.

 

 

 

 

 

 

 
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