Long Ratio Backspreads

Long Ratio Backspreads allow a trader to look at an outright long or short position in the market without investing in a put or call, outright. In some instances, the ratio will allow the trader to execute a spread which will limit risk without limiting reward for the credit. The size of the contracts used and strike differential determine if the spread can be carried out for the credit, or maybe if it will likely be a debit. The closer the strike prices are the less market risk, but the greater the premium risk.

The letter Ratio Backspread can be a bullish strategy. Expect the stock to make a large move higher. Purchase calls then sell fewer calls with a lower strike, usually in the ratio of just one x 2 or 2 x 3. The lower strike short calls finance purchasing the greater number of long calls and the position is normally entered into cost-free or possibly a net credit. The stock has to make a large enough move for your gain in the long calls to conquer the loss from the short calls since the maximum loss reaches the long strike at expiration. Because the stock should make a large move higher for your back-spread to make a profit, use so long as a time to expiration as is possible.

The Trade
The Trade: AliBaba
Date Initiated: August 9, 2016
Options Used: CALLS
Strikes: 85/86
Credit Collected: .10
Max Risk: 90.00
Max Reward: Unlimited

The Exit
The Exit: Bullish BABA
Sell 1 Contracts August 19th 85 CALL
Buy 2 Contracts August 19th 86 CALLS
Total for Trade: Credit of .10
Sell the 1 extra 86 CALL for 12.00
creating a 1100.00 profit

But there is more…

Rules for Trading Long Option Ratio Backspread

An extended Backspread involves selling (short) at or in-the-money options and getting (long) a greater number of out-of-the-money options of the identical type. The Option Spread Strategies that’s sold must have higher implied volatility than the option bought. This is known as volatility skew. The trade needs to be created using a credit. That is, the amount of money collected on the short options needs to be in excess of the price tag on the long options. These the weather is easiest to satisfy when volatility is low and strike tariff of the long option is close to the stock price.

Risk will be the alteration in strikes X number of short options minus the credit. The risk is restricted and maximum at the strike of the long options.

The trade is great in every trading environments, specially when wanting to pick tops or bottoms in almost any stock, commodity or future.
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