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+408 Part Ill: Put Option Strategies 
+a LEAPS may be used as the long option in the spread. Recall that the object of the 
+spread is for the stock to be volatile, particularly to the upside if calls are used. If that 
+doesn't happen, and the stock declines instead, at least the premium captured from 
+the in-the-money sale will be a gain to offset against the loss suffered on the longer­
+term calls that were purchased. The strategy can be established with puts as well, in 
+which case the spreader would want the underlying stock to fall dramatically while the 
+spread was in place. 
+Without going into as much detail as in the examples above, the diagonal back­
+spreader should realize that he is going to have a significant debit in the spread and 
+could lose a significant portion of it should the underlying stock fall a great deal in 
+price. To the upside, his LEAPS calls will retain some time value premium and will 
+move quite closely with the underlying common stock. Thus, he does not have to buy 
+as many LEAPS as he might think in order to have a neutral spread. 
+Example: XYZ is at 105 and a spreader wants to establish a backspread. Recall that 
+the quantity of options to use in a neutral strategy is determined by dividing the 
+deltas of the two options. Assume the following prices and deltas exist: 
+Option 
+April 100 call 
+July 110 call 
+January (2-year) LEAPS 100 call 
+XYZ: 105 in January 
+Price 
+8 
+5 
+15 
+Delta 
+0.75 
+0.50 
+0.60 
+Two backspreads are available with these options. In the first, one would sell the 
+April 100 calls and buy the July llO calls. He would be selling 3-month calls and buy­
+ing 6-month calls. The neutral ratio is 0.75/0.50 or 3 to 2; that is, 3 calls are to be 
+bought for every 2 sold. Thus, a neutral spread would be: 
+Buy 6 July 110 calls 
+Sell 4 April l 00 calls 
+As a second alternative, he might use the LEAPS as the long side of the spread; he 
+would still sell the April 100 calls as the short side of the spread. In this case, his neu­
+tral ratio would be 0.75/0.60, or 5 to 4. The resulting neutral spread would be: 
+Buy 5 January LEAPS 110 calls 
+Sell 4 April 100 calls