What is Call Backspread?

The Call Backspread is reverse of call ratio spread. It is bullish strategy that involves selling options at lower strikes and buying higher number of options at higher strikes of the same underlying stock. It is unlimited profit and limited risk strategy.

When to initiate the Call Backspread

The Call Backspread is used when an option trader thinks that the underlying asset will experience significant upside movement in the near term.

How to construct the Call Backspread?

• Sell 1 ITM/ATM Call

• Buy 2 OTM Call

The Call Backspread is implemented by selling one In-the-Money (ITM) or At-the-Money (ATM) call option and simultaneously buying two Out-the-Money (OTM) call options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Let’s try to understand with an Example:

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will rise significantly above Rs 9400 on or before expiry, then he initiates Call Backspread by selling one lot of 9300 call strike price at Rs 140 and simultaneously buying two lot of 9400 call strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be unlimited if underlying assets break upper breakeven point. However, maximum loss would be limited to Rs 7,500 (100*75) and it will only occur when Nifty expires at 9400.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Call Backspread, then the Delta would be negative, which means even if the underlying assets falls below lower BEP, profit will be the net premium received.

If the net premium is paid then the Delta would be positive which means any upside movement will result into profit.

Vega: The Call Backspread has a positive Vega, which means an increase in implied volatility will have a positive impact.

Theta: With the passage of time, Theta will have a negative impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Call Backspread has a long Gamma position, which means any major upside movement will benefit this strategy.

How to manage risk?

The Call Backspread is exposed to limited risk; hence one can carry overnight position.

Analysis of Call Backspread:

The Call Backspread is best to use when an investor is extremely bullish because investor will make maximum profit only when stock price expires above higher (bought) strike.