Todd Horwitz – Long Ratio Backspreads (Bubba’s Playbook pgs 9 – 11)

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Long Ratio Backspreads

Long Ratio Backspreads allow an explorer to consider an outright short or long position available in the market without purchasing a put or call, outright. In some cases, the ratio will allow the trader to execute a spread that can limit risk without limiting reward for the credit. The size of the contracts used and strike differential determine in the event the spread is possible for the credit, or if it will be a debit. The closer the strike price is the less market risk, however the more premium risk.

The Call Ratio Backspread is really a bullish strategy. Expect the stock to create a large move higher. Purchase calls and sell fewer calls at the lower strike, usually in a ratio of just one x 2 or 2 x 3. The lower strike short calls finance purchasing the more long calls and the position is generally applied for cost-free or even a net credit. The stock must make a big enough move for your grow in the long calls to overcome losing in the short calls because the maximum loss are at the long strike at expiration. Because the stock has to make a large move higher for your back-spread to create a profit, use so long as a moment to expiration as possible.

The Trade
The Trade: AliBaba
Date Initiated: August 9, 2016
Options Used: CALLS
Strikes: 85/86
Credit Collected: .10
Max Risk: 90.00
Max Reward: Unlimited

The Exit
The Exit: Bullish BABA
Sell 1 Contracts August 19th 85 CALL
Buy 2 Contracts August 19th 86 CALLS
Total for Trade: Credit of .10
Sell the 1 extra 86 CALL for 12.00
creating a 1100.00 profit

But there is more…

Rules for Trading Long Option Ratio Backspread

A long Backspread involves selling (short) at or in-the-money options and buying (long) a large number of out-of-the-money options of the identical type. The Bubba’s Instant Cash Flow that’s sold really should have higher implied volatility than the option bought. This is known as volatility skew. The trade needs to be made out of a credit. That is, the money collected about the short options needs to be more than the price of the long options. These the weather is easiest to meet when volatility is low and strike tariff of the long options nearby the stock price.

Risk could be the improvement in strikes X number of short options minus the credit. The risk is limited and maximum with the strike of the long options.

The trade is great in most trading environments, especially when trying to pick tops or bottoms in any stock, commodity or future.
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