Put Backspread Explained - Back Spread Options Strategy

Nilesh Jain

01 Jun 2017

New Page 1

What is Put Backspread?

The Put Backspread is reverse of Put Ratio Spread. It is a bearish strategy that involves selling options at higher strikes and buying higher number of options at lower strikes of the same underlying asset. It is unlimited profit and limited risk strategy.

When to initiate the Put Backspread

The Put Backspread is used when an option trader believes that the underlying asset will fall significantly in the near term.

How to construct the Put Backspread?

  • Sell 1 ITM/ATM Put

  • Buy 2 OTM Put

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

Strategy

Put Backspread

Market Outlook

Significant downside movement

Upper Breakeven

Strike price of short put -/+ premium paid/ premium received

Lower Breakeven

Long put strike - Difference between Long and Short strikes (-/+) premium received or paid

Risk

Limited

Reward

Unlimited (when Underlying price < strike price of buy put)

Margin required

Yes

Let’s try to understand with an Example:


NIFTY Current market Price Rs

9300

Sell ATM Put (Strike Price) Rs

9300

Premium received (Rs)

140

Buy OTM Put (Strike Price) Rs

9200

Premium paid (per lot) Rs

70

Net Premium Paid/Received Rs

0

Upper BEP

9300

Lower BEP

9100

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will fall significantly below 9200 on or before expiry, then he can initiate Put Backspread by selling one lot of 9300 put strike price at Rs 140 and simultaneously buying two lot of 9200 put 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 asset breaks lower breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9200.

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 Put Sold (Rs)

Net Payoff from 9200 Put Bought (Rs) (2Lots)

Net Payoff (Rs)

8700

-460

860

400

8800

-360

660

300

8900

-260

460

200

9000

-160

260

100

9100

-60

60

0

9150

-10

-40

-50

9200

40

-140

-100

9250

90

-140

-50

9300

140

-140

0

9350

140

-140

0

9400

140

-140

0

9450

140

-140

0

9500

140

-140

0

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is paid, then the Delta would be negative, which means any upside movement will result into premium loss, whereas a big downside movement would result in to unlimited profit. On the other hand, If the net premium is received from the Put Backspread, then the Delta would be positive, which means any upside movement above higher breakeven will result into profit up to premium received.

Vega: The Put 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 Put Backspread has a long Gamma position, which means any major downside movement will benefit this strategy.

How to manage Risk?

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

Analysis of Put Backspread:

The Put Backspread is best to use when investor is extremely bearish because investor will make maximum profit only when stock price expires at below lower (bought) strike.

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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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Put Backspread Explained - Back Spread Options Strategy

Nilesh Jain

01 Jun 2017

New Page 1

What is Put Backspread?

The Put Backspread is reverse of Put Ratio Spread. It is a bearish strategy that involves selling options at higher strikes and buying higher number of options at lower strikes of the same underlying asset. It is unlimited profit and limited risk strategy.

When to initiate the Put Backspread

The Put Backspread is used when an option trader believes that the underlying asset will fall significantly in the near term.

How to construct the Put Backspread?

  • Sell 1 ITM/ATM Put

  • Buy 2 OTM Put

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

Strategy

Put Backspread

Market Outlook

Significant downside movement

Upper Breakeven

Strike price of short put -/+ premium paid/ premium received

Lower Breakeven

Long put strike - Difference between Long and Short strikes (-/+) premium received or paid

Risk

Limited

Reward

Unlimited (when Underlying price < strike price of buy put)

Margin required

Yes

Let’s try to understand with an Example:


NIFTY Current market Price Rs

9300

Sell ATM Put (Strike Price) Rs

9300

Premium received (Rs)

140

Buy OTM Put (Strike Price) Rs

9200

Premium paid (per lot) Rs

70

Net Premium Paid/Received Rs

0

Upper BEP

9300

Lower BEP

9100

Lot Size

75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will fall significantly below 9200 on or before expiry, then he can initiate Put Backspread by selling one lot of 9300 put strike price at Rs 140 and simultaneously buying two lot of 9200 put 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 asset breaks lower breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9200.

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 Put Sold (Rs)

Net Payoff from 9200 Put Bought (Rs) (2Lots)

Net Payoff (Rs)

8700

-460

860

400

8800

-360

660

300

8900

-260

460

200

9000

-160

260

100

9100

-60

60

0

9150

-10

-40

-50

9200

40

-140

-100

9250

90

-140

-50

9300

140

-140

0

9350

140

-140

0

9400

140

-140

0

9450

140

-140

0

9500

140

-140

0

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is paid, then the Delta would be negative, which means any upside movement will result into premium loss, whereas a big downside movement would result in to unlimited profit. On the other hand, If the net premium is received from the Put Backspread, then the Delta would be positive, which means any upside movement above higher breakeven will result into profit up to premium received.

Vega: The Put 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 Put Backspread has a long Gamma position, which means any major downside movement will benefit this strategy.

How to manage Risk?

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

Analysis of Put Backspread:

The Put Backspread is best to use when investor is extremely bearish because investor will make maximum profit only when stock price expires at below lower (bought) strike.

Have Referral Code?