What is Call Backspread?

Nilesh Jain

01 Jun 2017

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.

Have Referral Code?

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
mutual-fund

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. 


Banner

What is Call Backspread?

Nilesh Jain

01 Jun 2017

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.

Have Referral Code?