28 lines
1.8 KiB
Plaintext
28 lines
1.8 KiB
Plaintext
Backspreads
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Definition : An option strategy consisting of more long options than short
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options having the same expiration month. Typically, the trader is long calls
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(or puts) in one series of options and short a fewer number of calls (or puts)
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in another series with the same expiration month in the same option class.
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Some traders, such as market makers, refer generically to any delta-neutral
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long-gamma position as a backspread.
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Shades of Gray
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In its simplest form, trading a backspread is trading a one-by-two call or put
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spread and holding it until expiration in hopes that the underlying stock’s
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price will make a big move, particularly in the more favorable direction.
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But holding a backspread to expiration as described has its challenges. Let’s
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look at a hypothetical example of a backspread held to term and its at-
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expiration diagram.
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With the stock at $71 and one month until March expiration:
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In this example, there is a credit of 3.20 from the sale of the 70 call and a
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debit of 1.10 for each of the two 75 calls. This yields a total net credit of
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1.00 (3.20 − 1.10 − 1.10). Let’s consider how this trade performs if it is held
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until expiration.
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If the stock falls below $70 at expiration, all the calls expire and the 1.00
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credit is all profit. If the stock is between $70 and $75 at expiration, the 70
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call is in-the-money (ITM) and the −1.00 delta starts racking up losses
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above the breakeven of $71 (the strike plus the credit). At $75 a share this
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trade suffers its maximum potential loss of $4. If the stock is above $75 at
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expiration, the 75 calls are ITM. The net delta of +1.00, resulting from the
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+2.00 deltas of the 75 calls along with the −1.00 delta of the 70 call, makes
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money as the stock rises. To the upside, the trade is profitable once the
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stock is at a high enough price for the gain on the two 75 calls to make up |