Ratio Back " CallSpread " ... Just a few questions

M

md2324

I was reading n article written on trading Ratio Back CallSpreads , and it mentioned only doing them when you are expecting a BIG Move to happen in the stock.

In reading the article and taking notes.... I still want to get clarification on a few things and make sure I am understanding correctly

1. It mentioned that you want to do this strategy , on Options with " Increased " volatility
So does this mean, that you ONLY want to do a Ratio Back CallSpread on stocks that have a IV Rank ( via TorS ) that are in the 50%+ IV Rank area ?

2. An example of a trade the article mentioned .... Had the stock trading at $135
You Sell one $140 OTM call that has a delta of .50
You Buy two $150 further OTM calls that each have a Delta of .39 ( for a combined Delta of .78 )

So the positions Delta = .28 ( .78 - .50 )

It said that for every $1 rise in the stock, that the trade will gain 28% of that

Does this mean that for every $1 that the stock goes up in price..... that I will make $28 on my trade ( position ) ?


Thanks for the help ,
I appreciate it
 
not really. It is likely that as the stock goes up, implied vol will decrease, reducing your profit. When you do these spreads, you need a quick move in the direction you are targeting. I feel they work better for bearish bets. Buy two puts OTM and sell one closer to the stock price. In general, as stocks fall, implied vol tends to increase, unless there was just an event like earnings.
 
Robert,
I appreciate your contribution to the thread and for your reply

Yeah, I can see what you mean about doing these Backspreads , when I am Bearish on a stock vs Bullish ..... as a stock tends to always fall faster and harder in one fail swoop , as it does when it goes upwards in price.

I am trying to use TorS's IV Rank volatility tool to an anvantage in trading these Backspreads and or Options in general ,
But don't want to solely rely on ..... oh hey, the IV Rank for NKE is at 70% ( so only sell credit spreads .... so say all of the books and webinars ) , when my charts and studying of literally thousands upon thousands of charts , is screaming at me that this thing is poised to make a significant move higher , and I'd rather BUY an outright Long Call option
VS
do what I've heard, which is to only sell naked or sell Credit spreads , given the IV Rank of NKE being at 70% ( in this example )

Is there any other 1 or 2 Indicators or metrics that I can use with the IV Rank, to filter out and or confirm to stick to what the books say, and only sell for a credit when IV is high
OR
Throw that out the window, and get Long an outright Call or Put ..... because another 1 or 2 indicators are telling me a different " Story " ? :)
 
I look at option trading differently. I like to come up with a thesis 1st. Vol is too high, too low, skew is wrong (for vol trading) or, I expect that the underlying will do X or not do Y. With that in hand and certain expectations, look for the options or combinations that gives me the best chance to make money if I'm right, and limit my losses if I'm wrong.

Certain strategies don't need that. I have a few clients that sell OTM short term options or credit spreads, or ratios. That is all about risk management, sizing and discipline.

You have to find what works for you. I've never used the TOS tool you are talking about. I don't know how to use it to your advantage.
 
md2324 said:
I was reading n article written on trading Ratio Back CallSpreads , and it mentioned only doing them when you are expecting a BIG Move to happen in the stock.

In reading the article and taking notes.... I still want to get clarification on a few things and make sure I am understanding correctly

1. It mentioned that you want to do this strategy , on Options with " Increased " volatility
So does this mean, that you ONLY want to do a Ratio Back CallSpread on stocks that have a IV Rank ( via TorS ) that are in the 50%+ IV Rank area ?

2. An example of a trade the article mentioned .... Had the stock trading at $135
You Sell one $140 OTM call that has a delta of .50
You Buy two $150 further OTM calls that each have a Delta of .39 ( for a combined Delta of .78 )

So the positions Delta = .28 ( .78 - .50 )

It said that for every $1 rise in the stock, that the trade will gain 28% of that

Does this mean that for every $1 that the stock goes up in price..... that I will make $28 on my trade ( position ) ?


Thanks for the help ,
I appreciate it
More...

For this trade, you do want movement in the stock, preferably a large move upward.

For a backspread, more options are purchased than sold. Looking at the graph, you would, for example, buy two calls at B, the higher strike. And you would sell one call at A, generally resulting in a net credit. My opinion is you should choose your strikes based on your expectations of what the underlying will do. With this trade, you either expect the stock to either make a decent move up, or if not stay the same or drift lower.

If the underlying stays at A or below, you collect the credit and the calls would expire worthless. Your max loss would be at B, the underlying settling at the strike of your 2 long calls at expiry. Your loss would be the difference between your long and short strikes, less the credit received.

Once the underlying moves beyond B, then your second call will begin to profit for you, and to take advantage of this, you want a large move.


back_spread_calls_big.png
 
I did alot of research and have traded this structure.. I think about deep otm options as the markets price on a rare event.. how impossible that is to price.. so if your selling an otm, and buying more farther otm.. your just trading one level of rarity against the other.. most of the time you won't make money.. it might make more sense if you were short a ton of straddles and wanted deep otm tail risk hedge ...Your not obligated to have a inventory of options.. so why bother.. Think about barrier options and how similar they are in profit graph.. convexity exponentializes near the bought strike much like a barrier.. increasing skew will help you if your long the backspread. problem with all this is bigger influences are responsible for your pnl... I personally have had it the underlying expire right near the short strike, it sucks...
 
This is not a trade when you really believe a stock will move big upward. Then you will just buy the call. You can split the trade in two parts. Part 1 is you are bearish :You sell ATM call and buy OTM for your protection. This part is a credit spread. So far you believe the stock will go down. Now you have made some money by selling that credit spread. You use that money for gambling. Part 2: You buy another OTM call. Depending how far out of the money the call is, you still end up making money {credit} (ATM> 2x OTM). If a crazy situation happens and the stock goes out of whack, you will make money (gambling or buying lottery) You can also add another leg by selling one more out of the money Call to limit your profit and reduce cost.
 
In my experience, I can make a case for +1 OTM call and -2 or -3 more OTM calls. Even though you are often buying an Ivol that is higher than the few that you are selling, if it's a credit and you believe that stock can't move up quickly, it can work well over time. The big risk is upside news.

I can also make a case for the reverse spread for index options as long as the total is flat or a credit. Selling 1 OTM put and buying 2 or 3 more OTM puts, will set up some tail risk protection for the rest of your portfolio. You are buying the higher iVol, but they will remain higher until they expire. It works better if it's not short term options. I would look out around 3 months and roll when they get 2 to 3 weeks. This would have a lot of risk with less time to expiration. You will need a plan to exit this. You don't want to hold it for ever. You will want to exit near expiration or after a big down move when Ivol is elevated.

Just my opinion.
 
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