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  Call Back Spread  ( Other Bullish: Long Call - Covered Call - Protective Put - Bull Call Spread - Bull Put Spread - Naked Put )

 

Call back spread strategy chart

Call backspreads are great strategies when you are expecting big moves in already volatile stocks. The trade itself involves selling a call (or calls) at a lower strike and buying a greater number of calls at a higher strike price. Ideally, this trade is initiated for a minimal debit or possibly a small credit. This way, if the stock heads south, you won't suffer much either way. On the other hand, if the stock takes off, the profit potential will be unlimited because you have more long than short calls. To maximize the potential for this position, many traders use in-the-money options because they have a higher likelihood of finishing in-the-money.

 

Example

Using International Paper (NYSE: IP), a company that historically has been quite volatile, we can create a ratio backspread using in-the-money options.

In this case, you might buy two of the JUL 45 calls at $1.05 and sell one 40 call at $4.00.

 

IP Trading @ $43.46

Buy

IP JUL 45 Call @ $1.05

$210

Sell

IP JUL 40 Call @ $4.00

($400)

Credit from Trade

($190)

 

In this case, you would receive $190 ((4.00 - 2.10) x 100 shares) for putting on the trade. If the stock dropped below $40, you would keep the $190. However, the real money would be made if the stock made a huge move to the upside. The upside breakeven for this trade would be $48.10. At this price, the 40 calls would be worth $8.10 (8.10 x 1) each while the 45 calls would be worth $6.20 (3.10x2). Factoring in the initial $190 credit, the ROI at this price would be 0. Above $48.10, the profit potential is unlimited.

 

 

Call Back Spread ChartCall Back Spread Graph

 

Calculating the Breakeven
 
The easiest way to calculate the upside breakeven is by using the following formula:
 
Upside Breakeven = Long strike price + [(Long strike - short strike) x # of short contracts] - net credit/100*

 
*(or + net debit)

 
Using the data for this example, the breakeven calculation looks like this:
 
45 + [(45 - 40) x 1] - 190/100
 
The maximum loss for this trade would occur with the stock at 45 because the long calls would be worthless and the short call would be worth $5. Factoring in the initial credit of $190, the maximum loss on this trade would be $310 (1 contact x $5 x 100 shares - $190 credit).
 

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