Backspread with Calls – Bullish (Bearish)
If you are an investor or trader, chances are that you’ve heard about various trading strategies. One of these strategies is the Backspread with Calls. It’s a strategy that can be used to take advantage of a bullish or bearish market trend.
Firstly, what is a call option? A call option gives the buyer the right to buy an underlying asset at a predetermined price within a certain time frame. The seller of the call option has the obligation to sell that asset if and when the buyer decides to exercise their right to buy it.
The Backspread with Calls strategy involves buying more calls than selling them, which makes it similar to an options spread trade. However, unlike most other spread trades where both legs have the same expiration date and strike price, this strategy involves buying calls at different strike prices while still having all options expire on the same date.
A bullish backspread with calls involves buying one higher-priced call option and selling two lower-priced ones for net credit (meaning you receive more in premium for your sold options than you pay for your purchased one). This type of trade assumes there will be significant upward movement in the underlying security. Conversely, a bearish backspread would involve selling one higher-priced call and purchasing two lower-priced ones for net debit (you pay more in premium for your purchased options compared to what you receive from selling).
In essence, by using this strategy investors can benefit from large moves up or down in stock prices without risking too much capital upfront. But note that you stand to lose money if prices remain stagnant or move only slightly against your position as both bought options will become worthless before expiry while leaving short positions open.
Let’s illustrate how this works using some examples:
Bullish Backspread Example
Assume XYZ stock is currently trading at $100 per share and we believe its value will significantly increase over time due to positive news announcements. We then decide to open a bullish backspread with calls position on this stock.
We buy one call option with a strike price of $105 for a premium of $2 per share and sell two call options at the strike price of $100 for premiums totaling $4 ($2 each). This results in a net credit of $2 per share (or $200 total credit since each contract represents 100 shares).
If XYZ’s stock value increases as we anticipated and reaches above the higher strike price ($105), our purchased option will be “in the money” and become valuable while both sold options will expire worthless, resulting in profits that are limited only by how much higher than our upper strike price it climbs.
However, if XYZ’s stock fails to increase significantly or even declines before expiration, all three contracts will become worthless due to their expiring out-of-the-money status. The maximum potential loss would be equal to the net debit paid upfront when entering into this trade (i.e., zero profit from selling two calls minus $2 premium paid for buying one).
Bearish Backspread Example
Assume instead that we believe XYZ’s value is going to decrease significantly due to negative news reports in the upcoming weeks. In such case, we decide opening a bearish backspread with calls position on this stock would be most appropriate.
We sell one call option with a strike price of $95 for a premium amounting to $3 and purchase two call options at the lower strike price of $100 for premiums totaling just under what was received from selling ($5). In total, this creates a net debit position equivalent to about half as much as was spent purchasing these contracts alone (i.e., around -$2/share or -$200 overall).
If XYZ’s stock drops below our lower-strike-price ($100), both purchased options will still have some intrinsic value left while our sold option expires worthless. At expiry date, profits can be taken at the difference between the price of XYZ stock and our higher call option’s strike price. However, if we’re wrong and prices instead rise or remain unchanged, both purchased calls will become worthless while our sold option will become profitable – leading to losses.
In summary, backspread with calls is a trading strategy that can be used in bullish or bearish markets depending on your outlook for an underlying asset. It involves buying a call option at a higher strike price than selling two options at lower strike prices with all expiring simultaneously. The risks are limited but so are potential gains since profits depend highly on how much the underlying security moves up or down in value before expiration.