Long Ratio Backspreads

Long Ratio Backspreads allow an angel investor to look at an outright long or short position out there without getting a put or call, outright. In certain instances, the ratio will permit the trader to do a spread that can limit risk without limiting reward for the credit. The size the contracts used and strike differential will determine when the spread can be achieved for the credit, or if it will likely be a debit. The closer the strike price is the less market risk, though the more premium risk.

The phone call Ratio Backspread is often a bullish strategy. Expect the stock to create a large move higher. Purchase calls and then sell on fewer calls in a lower strike, usually inside a ratio of a single x 2 or 2 x 3. The lower strike short calls finance purchasing the more long calls along with the position is normally created for no cost or possibly a net credit. The stock has to come up with a big enough move to the gain in the long calls to get over the loss within the short calls because the maximum loss is at the long strike at expiration. Because the stock needs to come up with a large move higher to the back-spread to create a profit, use so long as a period to expiration as you can.

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

A protracted Backspread involves selling (short) at or in-the-money options and buying (long) more out-of-the-money options of the same type. The Option Spread Strategies that’s sold should have higher implied volatility compared to option bought. This is termed volatility skew. The trade must be created using a credit. That’s, how much money collected on the short options must be more than the price of the long options. These conditions are easiest in order to meet when volatility is low and strike price of the long option is nearby the stock price.

Risk could be the improvement in strikes X variety of short options minus the credit. The risk is bound and maximum at the strike in the long options.

The trade itself is great in all of the trading environments, particularly when looking to pick tops or bottoms in any stock, commodity or future.
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