example, this 1:2 contract backspread has a delta of −0.02 and a gamma of
+0.05. Fewer than 10 deltas could be scalped if the stock moves up and
down by one point. It becomes a more practical trade as the position size
increases. Of course, more practical doesn’t necessarily guarantee it will be
more profitable. The market must cooperate!
Backspread Example
Let’s say a 20:40 contract backspread is traded. (Note : In trader lingo this is
still called a one-by-two; it is just traded 20 times.) The spread price is still
1.00 credit per contract; in this case, that’s $2,000. But with this type of
trade, the spread price is not the best measure of risk or reward, as it is with
some other kinds of spreads. Risk and reward are best measured by delta,
gamma, theta, and vega. Exhibit 16.2 shows this trade’s greeks.
EXHIBIT 16.2 Greeks for 20:40 backspread with the underlying at $71.
Backspreads are volatility plays. This spread has a +1.07 vega with the
stock at $71. It is, therefore, a bullish implied volatility (IV) play. The IV of
the long calls, the 75s, is 30 percent, and that of the 70s is 32 percent. Much
as with any other volatility trade, traders would compare current implied
volatility with realized volatility and the implied volatility of recent past
and consider any catalysts that might affect stock volatility. The objective is
to buy an IV that is lower than the expected future stock volatility, based on
all available data. The focus of traders of this backspread is not the dollar
credit earned. They are more interested in buying a 30 volatility—that’s the
focus.
But the 75 calls’ IV is not the only volatility figure to consider. The short
options, the 70s, have implied volatility of 32 percent. Because of their