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