Call Backspread
Note: A Backspread is also called a Ratio Spread.
Components
Short one ITM call option and long two OTM call options.
Risk / Reward
Maximum Loss: Limited to the difference between the two strikes plus the net premium (which should be a credit).
Maximum Gain: Unlimited on the upside and limited on the downside.
Characteristics
Similar to a Short Straddle except the loss on the downside is limited.
When to use: When you are bullish on volatility and bullish on market price. Note though, that you profit when prices fall, although the gains are greater if the market rallies.
A Backspread looks a lot like a Long Straddle except the payoff flattens out on the downside. The other key difference is that Backspreads are usually done at a credit. That is, the net difference for both legs means that you receive money into your account up front instead of paying (debit) for the spread.
Even though the payoff looks like a "long" type position, it is often referred to as a "short" strategy. Generally it is like this: if you receive money for the position up front it is called a "Short" position and when you pay for a position it is called being "Long".
Comments (2)
Peter
May 21st, 2009 at 6:12am
Hi Brett,
Yes, it is more than the net premium...the max loss is the difference between the two strikes less the net premium. Or technically plus the net premium...but as the premium is a credit (-ve) you will subtract it.
I have clarified it above too. Thanks!
Brett
May 20th, 2009 at 6:18am
I'm new to options, but couldn't the loss on a call backspread be much greater than just the net premium? If the market moved above the short ITM call you would have to pay and if the rally did not reach the long OTM calls those would expire worthless and you would be on the hook for the difference in the market and the short call, which could be substantial depending on the strike prices and commodity/stock involved. Do I have this right?
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