Long Ratio Backspreads

Long Ratio Backspreads allow an investor to adopt an outright long or short position available in the market without purchasing a put or call, outright. In some instances, the ratio will allow the trader to do a spread that may limit risk without limiting reward to get a credit. The sized the contracts used and strike differential determine if your spread is possible to get a credit, or if it’ll be a debit. The closer the strike cost is the less market risk, though the more premium risk.

The letter Ratio Backspread is a bullish strategy. Expect the stock to create a large move higher. Purchase calls and then sell fewer calls in a lower strike, usually within a ratio of 1 x 2 or 2 x 3. The lower strike short calls finance the purchase of the greater amount of long calls and also the position is generally entered into for no cost or even a net credit. The stock has to create a large enough move for your gain in the long calls to overcome the loss within the short calls because the maximum loss is a the long strike at expiration. Because the stock has to create a large move higher for your back-spread to create a profit, use for as long 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

A protracted Backspread involves selling (short) at or in-the-money options and buying (long) a greater number of out-of-the-money options of the same type. The Bubba’s Instant Cash Flow that is certainly sold needs to have higher implied volatility as opposed to option bought. This is termed volatility skew. The trade must be constructed with a credit. That is, how much money collected around the short options must be higher than the price of the long options. These the weather is easiest to satisfy when volatility is low and strike price of the long options nearby the stock price.

Risk could be the difference in strikes X variety of short options without the presence of credit. The risk is restricted and maximum on the strike of the long options.

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