What is Call Backspread?
01 Jun 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.