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Bull Call Backspread Option Strategy - Advanced Options Trading Concepts - YouTube
Channel: Option Alpha
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Hey everyone.
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This is Kirk, here again at optionalpha.com.
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And in this video, we鈥檙e going to talk about
a bullish strategy, the bull call backspread.
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I know it鈥檚 a big mouthful there, but it's
really a great strategy and an easy way to
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take a long position in a stock without taking
the extra risk of a general long option.
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Let鈥檚 get right into it here as always.
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The market outlook for the call backspread
here is that you are going to want to see
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a bullish move in the underlying stock.
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Typically, you want to see a pretty significant
upside move.
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What you want to do with this is you also
want to keep your downside risk limited.
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This is going to be a more limited downside
risk as opposed to just a regular call option.
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A regular call option would actually have
(at the lower strike here or the higher strike
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at 45) downside risk capped at this point
going out, so at $500.
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But with the call backspread, what you鈥檙e
actually going to do is just make that one
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point the maximum loss point and everything
beyond there, you actually might end up not
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making any money, but at least you won鈥檛
lose any money.
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That's the whole idea with the bull call backspread.
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How do you set this up?
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It鈥檚 a little bit more complex than your
average run-of-the-mill strategy, but all
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you鈥檙e going to do is basically sell a number
of calls with a lower strike and buy twice
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that number of calls at the higher strike.
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In our example, we鈥檙e going to sell one
in the money 40 strike call and we鈥檙e going
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to buy two out of the money 45 strike calls.
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You just want to sell twice as many.
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If you want to do the spread as selling two
and buying four or selling 10 and buying 20,
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you can do that.
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As long as you have that 1:2 ratio, you should
be in good shape as far as building this strategy.
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What鈥檚 the risk of the strategy?
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The maximum loss would occur should the stock
close right at the upper strike price.
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If the stock closed right at 45, that would
create the maximum loss of $500 in this case.
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The reason that creates that loss is because
we are long two options at $45, so those options
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would expire worthless and then make no money
and then we'd be also short a 40 strike which
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would be $500 in the money, so we鈥檇 have
to buy that option back and that鈥檚 where
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the $500 loss comes into play as far as our
maximum area.
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Anything around 45 and it would be a differing
loss all coming back towards the zero barrier
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if we get beyond 40 and beyond 50.
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This is actually a pretty good strategy for
a market that is pretty volatile, highly volatile
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in either direction.
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It just has more of a bullish tilt to the
strategy than generally speaking.
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But it鈥檚 not a good strategy for sideways
or neutral markets and really, it鈥檚 flat
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out horrible for those types of markets.
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The profit potential for this strategy is
technically unlimited to the topside.
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The stock has no theoretical cap.
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It can go up forever.
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But you can also build a strategy, so that
it makes money by the stock falling and taking
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in a credit when the position opens.
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We鈥檒l go over this here at the end of the
video, but as you can see on my profit loss
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chart, I鈥檝e built this strategy for the
purposes of this example to make no money
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at all right at the zero barrier should the
stock close anywhere below 40.
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But if you build the strategy to where you
take in a small credit here, you can actually
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build this strategy to take in a small credit,
maybe $50 or $25, something that pays you
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back for your commissions already and then
it becomes more of a market neutral strategy.
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Let鈥檚 talk about volatility here.
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Increases in implied volatility all other
things being equal is going to have a very
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positive impact on this strategy.
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Remember that when we were building this strategy,
we were short one option at 40 and we were
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long two options at 45.
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We were short one at 40 and long two at 45.
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Remember that this extra long call option
here is going to have all of the Vega or volatility
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features of the strategy.
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The other two options are going to more or
less cancel themselves out.
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But since we鈥檙e long an extra call option,
it鈥檚 going to act more like a long option.
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And since volatility is great for the strategy,
big wild swings are great, that's what creates
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this profit zone up here, we want the stock
to move violently and move into a profit zone
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once we enter the trade.
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Time decay is actually going to have a negative
impact on this strategy.
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Since we are net long calls, the Theta overall
is going to hurt our position.
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Since we have that extra long call at 45,
then time decay is going to be working against
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us.
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We need the strategy or the underlying stock
to move into a profit zone.
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If it doesn't move, then every single day,
the option values are going to decay and we鈥檙e
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going to move more and more towards our maximum
loss feature.
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Just like volatility, the more out of the
money the calls are, the smaller the time
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decay effects are going to be.
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The more out of the money you have call options
that are long, the smaller the effects of
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time decay overall.
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Breakeven points are a little bit more complex
to calculate, but we鈥檙e going to go over
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both of them here.
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You can see we have two breakeven points since
this strategy crosses the profit loss line
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twice.
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The upper point is going to be the strike
price of the long calls plus the maximum loss
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that you can incur.
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In this case, the strike price is 45, the
maximum loss we can incur is 500, so we鈥檙e
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going to add that to 45, $5 per option and
that gives us that $50 strike right here.
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That鈥檚 the point at which we need the stock
to move for us to start to make money at expiration.
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If the stock is trading at 45 when we entered
this, we need it to move at least $5 just
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to break even.
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The lower point or the lower breakeven point
is going to be the strike price of the short
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call.
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You can see we sold a call at 40.
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If the stock moves down to 40, then we will
actually make no money on this trade, but
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we also won鈥檛 lose any money as well.
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Let鈥檚 look at a quick example.
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Let鈥檚 say the stock price is trading at
45.
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We鈥檙e going to sell one 40 call option for
$400.
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We鈥檙e going to sell this 40 strike for $400.
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We鈥檙e going to go out in the market and
buy two 45 calls for $200 apiece.
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Notice that the sale of the 40 strike call
is going to completely fund and provide the
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money for these two 45 strike calls at $200
apiece.
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This creates no debit or credit on this trade.
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The maximum loss here is $500.
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That's the strike minus the credit.
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If the stock closes right at 45, our two long
45 calls that we paid $200 each for are going
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to expire worthless and our short call option
at 40 is going to be $500 in the money.
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We鈥檙e going to have to buy that back to
close out the trade which creates that $500
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maximum loss.
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The maximum profit to the upside is unlimited.
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If the stock just continues to move higher,
that's great.
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That鈥檚 what we want with this strategy and
that creates that unlimited feature.
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You can create a little bit of a profit down
here by making sure that the sale of the one
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option is more than it cost to buy the other
two options at 45.
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For example: If the sale of the 40 brought
in $450 and it only cost you $200 each for
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the two long calls, you鈥檇 still be left
with a credit of $50, in which case, anything
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below 40 would make you a profit of $50 to
the downside.
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And that's much more of a market neutral strategy.
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And really, what I like to create when I trade
this is I like to create at least a little
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credit to the downside, so that if the market
does really flop over and go against what
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I think is going to happen, then at least
I鈥檓 bringing in some sort of income on the
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strategy overall.
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Some tips and tricks over the years: This
strategy is basically a bear call spread and
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a long extra call.
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Think of it like a bear credit spread where
you have a short option and a long option
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here and then we鈥檙e just adding that extra
long call to the strategy which creates this
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new backspread strategy.
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High volatility stocks where you can get into
the trade with no money are best.
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This trade cost us absolutely no money to
get into.
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Think about your account size.
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And if you want to create a strategy that
actually has upside profit potential and it
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doesn't cost you anything to get into, this
is a great one to trade if it鈥檚 on a high
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volatility stock.
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It is possible to structure the strategy to
make money if the stock falls.
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Just make sure that you sell the short call
for more than you purchase the two long calls
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for.
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That creates a little bit of a credit and
helps with your overall position and creates
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much more of a neutral strategy going forward.
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Thanks again for watching this video and I
hope you guys enjoyed it.
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