Long Ratio Backspreads
Long Ratio Backspreads allow an explorer to look at an outright short or long position available in the market without buying a put or call, outright. In some cases, the ratio allows the trader to execute a spread which will limit risk without limiting reward for a credit. The height and width of the contracts used and strike differential determine in the event the spread can be achieved for a credit, or if perhaps it will be a debit. The closer the strike cost is the less market risk, nevertheless the more premium risk.
The Call Ratio Backspread is often a bullish strategy. Expect the stock to make a large move higher. Purchase calls then sell fewer calls at a lower strike, usually in the ratio of 1 x 2 or 2 x 3. The lower strike short calls finance buying the more long calls and also the position is usually entered into for no cost or even a net credit. The stock must create a big enough move for the gain in the long calls to beat losing from the short calls as the maximum loss is at the long strike at expiration. Because the stock must create a large move higher for the back-spread to make a profit, use for as long an occasion to expiration as you possibly 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 purchasing (long) more out-of-the-money options of the same type. The Bubba’s Classified Option Report which is sold needs to have higher implied volatility compared to option bought. This is known as volatility skew. The trade must be made with a credit. That is, how much money collected for the short options must be more than the price of the long options. These conditions are easiest to fulfill when volatility is low and strike price of the long options at the stock price.
Risk is the difference in strikes X quantity of short options minus the credit. The risk is limited and maximum in the strike of the long options.
The trade is great in all trading environments, specially when looking to pick tops or bottoms in a stock, commodity or future.
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