Advanced options – the call ratio backspread, a very bullish strategy
Options are powerful financial tools that can deliver desired outcomes, but require understanding and careful use. Options are not suitable for everyone. However for those willing to take the time to understand options, the rewards can be significant.
This occasional series will examine some common option strategies for investors and traders with previous options trading experience. Those just starting on the education journey towards option trading may find a useful starting point here: Options Trading in Australia: How to Trade Options
The call ratio backspread is a very bullish strategy. It allows a lower initial cost while gaining exposure to strong moves upward in an index. The spread is not traded as a single strategy on the moomoo platform, but is created through two transactions – selling an index call outright, and then buying two calls of a higher strike.
Another possibility is the sale of a call spread, and the purchase of an additional call at the higher strike. All of the options have the same expiry date. Both methods create a -1 to +2 ratio of call options.
Here’s a scenario:
It’s the first week of June. Tony Trader has formed the view that the $S&P 500 Index (.SPX.US)$ will make a strong move higher over the coming two months. The current price of the S&P 500 is 5912, and the equivalent level in the $Mini Standard & Poor's 500 (.XSP.US)$ is 591.2. To take advantage of any potential move, Tony creates a call ratio backspread in the mini-S&P options market:
In selling one 600 Call and buying two 625 Calls Tony receives a credit of US $200 (less fees).
If Tony is completely wrong, and the index falls over the coming months, the options will expire worthless, and Tony gets to keep the US $200. The pay-off diagram below shows the profit and loss profile of this options structure at expiry. In summary, Tony keeps the initial credit if the market finishes below the lowest call strike (the sold call). If the market index rises a small amount Tony loses money, but if it rockets higher, he has unlimited upside profit potential.
This chart shows the potential pay out at expiry. Along the bottom axis is the value of the index at expiry. The vertical axis shows the US dollar value of the position.
– Below an index value at expiry of 602, Tony makes a small profit.
– Between 602 and 633, Tony loses money, with a maximum loss of $2,300 if the index finishes at the strike price of 625.
– At 633 the position moves into profit, and the profit increases as the value of the index gets higher. If Tony’s original idea is correct, and the index goes up 10% to 650 in the space of almost 4 months, the position would deliver a profit of US $5,000.
This is one example of a call backspread. There are many different option strike prices, and testing a variety of combinations to find the most desirable combination is common. It’s important to remember that there is no magic in derivatives, they are simply tools for re-shaping market risk. Examining various combinations allows traders to find the most desirable attributes for them – whether paying or receiving on the initial trade, and the levels at which they’d like to hit profitability.
It's important to note that backspreads can have higher and lower ratios. One sold call to three bought calls is the most common variation, possibly followed by two sold calls to three bought calls, although traders can tailor the ratio to their liking.
It’s worth repeating that the strategy is suitable where there is a view that a strong rally is coming. The strength of this option structure is that it gives exposure to big gains with a small initial cost or even a credit. These benefits come at a market cost – a mild move upward (the right direction) results in a loss for the trader. However the call backspread is a powerful tool for those who make the effort to understand the risks and potential benefits.
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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Michael McCarthy CEO
moomoo AU CEO
Australia - Asia Pacific - macro / market strategist.
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All in Man : Very interesting strategy. I didn't know it could be done this way. I've learned something new again![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")
Michael McCarthy CEO OP All in Man : That's the beauty of the moomoo community - we can all learn from each other. Hope you find it useful
Piggy Bank Trader : If you have 100 shares to sell a covered call, why not just sell a weekly at your current avg (assuming you buy shares tomorrow and immediately sell the call) and make 500-600 a week? Rinse and repeat.
There will be weeks that the drock price falls below your purchase price of the stocks, but generally you can still sell an a call with a strike to match your avg for at least $100+.
A much larger return on capital and you are more flexible and not locked in.
Michael McCarthy CEO OP Piggy Bank Trader : Fair comment - the beauty of the options market is that are many different ways for investors and traders to achieve their aims
104704662 :![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")
Ronzo07 : ok
candysst : g
大马周瑜 : ok
Mimi112 : amazing
☆MoMo☆ :![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")
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