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training_data/curated/text/d063d6cdce83de8ec743c1fe509f4fb09c66d294ee9d4b5eeb5458c3fe75d6f9.txt

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+With the backspread, the changing gamma adds one more element of risk.
+In this example, buying stock to flatten out delta as the stock falls can
+sometimes be a premature move. Traders who buy stock may end up with
+more long deltas than they bargained for if the stock falls into negative-
+gamma territory.
+Exhibit 16.3 shows that with the stock at $68, the delta for this trade is
+−2.50. If the traders buy 250 shares at $68, they will be delta neutral. If the
+stock subsequently falls to $62 a share, instead of being short 1.46 deltas, as
+the figure indicates, they will be long 1.04 because of the 250 shares they
+bought. These long deltas start to hurt as the stock continues lower.
+Backspreaders must therefore anticipate stock movements to avoid
+overhedging. The traders in this example may decide to lean short if the
+stock shows signs of weakness.
+Leaning short means that if the delta is −2.50 at $68 a share, the traders
+may decide to underhedge by buying just 100 or 200 shares. If the stock
+continues to fall and negative gamma kicks in, this gives the traders some
+cushion to the downside. The short delta of the position moves closer to
+being flat as the stock falls. Because there is a long strike and a short strike
+in this delta-neutral position, trading ratio spreads is like trading a long and
+a short volatility position at the same time. Trading backspreads is not an
+exact science. The stock has just as good a chance of rising as it does of
+falling, and if it does rise and the traders have underhedged at $68, they will
+not participate in all the gains they would have if they had fully hedged by
+buying 250 shares of stock. If trading were easy, everyone would do it!
+Backspreaders must also be conscious of the volatility of each leg of the
+spread. There is an inherent advantage in this example to buying the lower
+volatility of the 75 calls and selling the higher volatility of the 70 calls. But
+there is also implied risk. Equity prices and IV tend to have an inverse
+relationship. When stock prices fall—especially if the drop happens quickly
+—IV will often rise. When stock prices rise, IV often falls.
+In this backspread example, as the stock price falls to or through the short
+strike, vega becomes negative in the face of a potentially rising IV. As the
+stock price rises into positive vega turf, there is the risk of IV’s declining. A
+dynamic volatility forecast should be part of a backspread-trading plan. One
+of the volatility questions traders face in this example is whether the two-