Article

What is Call Backspread?

10 Jul 2017 Nilesh Jain

New Page 1

The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling options at lower strikes and buying higher number of options at higher strikes of the same underlying stock. It is unlimited profit and limited risk strategy.

When to initiate the Call Backspread

The Call Backspread is used when an option trader thinks that the underlying asset will experience significant upside movement in the near term.

How to construct the Call Backspread?

  • Sell 1 ITM/ATM Call

  • Buy 2 OTM Call

The Call Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money (ATM) call option and simultaneously buying two Out-the-Money (OTM) call options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Call Backspread

Market Outlook

Significant upside movement

Upper Breakeven

Long call strikes + Difference between long and short strikes -/+ net premium received or paid

Lower Breakeven

Strike price of Short call +/- net premium paid or received

Risk

Limited

Reward

Unlimited (when Underlying price > strike price of buy call)

Margin required

Yes

Let’s try to understand with an Example:

NIFTY Current market Price Rs

9300

Sell ATM Call (Strike Price) Rs

9300

Premium Received (per share) Rs

140

Buy OTM Call (Strike Price) Rs

9400

Premium Paid (per lot) Rs

70

Net Premium Paid/Received

0

Upper BEP

9500

Lower BEP

9300

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise significantly above Rs 9400 on or before expiry, then he initiates Call Backspread by selling one lot of 9300 call strike price at Rs 140 and simultaneously buying two lot of 9400 call strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be unlimited if underlying assets break upper breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9400.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Call Sold (Rs)

Net Payoff from 9400 Call Bought (Rs) (2Lots)

Net Payoff (Rs)

9000

140

-140

0

9100

140

-140

0

9200

140

-140

0

9300

140

-140

0

9350

90

-140

-50

9400

40

-140

-100

9450

-10

-40

-50

9500

-60

60

0

9600

-160

260

100

9700

-260

460

200

9800

-360

660

300

9900

-460

860

400

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Call Backspread, then the Delta would be negative, which means even if the underlying assets falls below lower BEP, profit will be the net premium received.

If the net premium is paid then the Delta would be positive which means any upside movement will result into profit.

Vega: The Call Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact.

Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Call Backspread has a long Gamma position, which means any major upside movement will benefit this strategy.

How to manage risk?

The Call Backspread is exposed to limited risk; hence one can carry overnight position.

Analysis of Call Backspread:

The Call Backspread is best to use when an investor is extremely bullish because investor will make maximum profit only when stock price expires above higher (bought) strike.

Similar Articles
  • Responses
  • Patidar Samaj

    - 2 hrs ago

    This article claims RJio was given a "Backdoor Entry" into the 4G Based Voice Routing. The peculiar aspect is without the Voice License, Rjio would have been a mere ISP. With the license, it is now a holistic communications service provider, with ability to exponentially scale the bouquet of products. The events indicate it was meticulously planned way before the auctions because the auctions were clear on the agenda: 4G for internet only.

Load More
Have Referral Code?

Recent Articles

Beginner's Corner

What is Call Backspread?

10 Jul 2017 Nilesh Jain

New Page 1

The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling options at lower strikes and buying higher number of options at higher strikes of the same underlying stock. It is unlimited profit and limited risk strategy.

When to initiate the Call Backspread

The Call Backspread is used when an option trader thinks that the underlying asset will experience significant upside movement in the near term.

How to construct the Call Backspread?

  • Sell 1 ITM/ATM Call

  • Buy 2 OTM Call

The Call Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money (ATM) call option and simultaneously buying two Out-the-Money (OTM) call options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy

Call Backspread

Market Outlook

Significant upside movement

Upper Breakeven

Long call strikes + Difference between long and short strikes -/+ net premium received or paid

Lower Breakeven

Strike price of Short call +/- net premium paid or received

Risk

Limited

Reward

Unlimited (when Underlying price > strike price of buy call)

Margin required

Yes

Let’s try to understand with an Example:

NIFTY Current market Price Rs

9300

Sell ATM Call (Strike Price) Rs

9300

Premium Received (per share) Rs

140

Buy OTM Call (Strike Price) Rs

9400

Premium Paid (per lot) Rs

70

Net Premium Paid/Received

0

Upper BEP

9500

Lower BEP

9300

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise significantly above Rs 9400 on or before expiry, then he initiates Call Backspread by selling one lot of 9300 call strike price at Rs 140 and simultaneously buying two lot of 9400 call strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be unlimited if underlying assets break upper breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9400.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Call Sold (Rs)

Net Payoff from 9400 Call Bought (Rs) (2Lots)

Net Payoff (Rs)

9000

140

-140

0

9100

140

-140

0

9200

140

-140

0

9300

140

-140

0

9350

90

-140

-50

9400

40

-140

-100

9450

-10

-40

-50

9500

-60

60

0

9600

-160

260

100

9700

-260

460

200

9800

-360

660

300

9900

-460

860

400

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Call Backspread, then the Delta would be negative, which means even if the underlying assets falls below lower BEP, profit will be the net premium received.

If the net premium is paid then the Delta would be positive which means any upside movement will result into profit.

Vega: The Call Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact.

Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Call Backspread has a long Gamma position, which means any major upside movement will benefit this strategy.

How to manage risk?

The Call Backspread is exposed to limited risk; hence one can carry overnight position.

Analysis of Call Backspread:

The Call Backspread is best to use when an investor is extremely bullish because investor will make maximum profit only when stock price expires above higher (bought) strike.