Backspreads Option Strategy
A backspread
is the opposite of a ratio,
so that more options of the same expiration are
bought than sold.
The purchase of two
March 105 calls for
$3, and the sale of one March 100 call for $5, is an
example of a 2 by 1 call backspread done for a $1
debit. Backspreads may be done in any ratio such as 3 by 2
or 3 by 1.
The investor must not
only be bullish on the market, but also expect the
market to move sharply higher as well. The investor
will actually lose money if the market creeps upward
and stays near the 105 level at expiration, as shown
in Figure 15.11. The loss potential is limited but
the profit potential is unlimited with these
spreads.
A put backspread
is similar
to a call backspread but more puts of the same
expiration are bought than sold.
The
purchase of 2 April
95 puts for $2, and the sale of 1 April 100 put for
$5, is an example of a 2 by 1 put back spread done
for a $1 credit.
Butterflies Option Strategy
A butterfly
is the purchase of one option on one strike, the
sale of two options on the next strike, and the
purchase of one option on the next strike, all of
the same expiration. For example, the purchase
of 1 May 95 call for $8, the sale of 2 May 100 calls
for $5, and the purchase of 1 May 105 call for $3,
is an example of buying a call butterfly for a $1
debit ($8 - (2 . $5) + $3 = $1). The purchase of 1
May 95 put for $2, 1 May 105 put for $9, and sale of
2 May 100 puts for $5 each, is an example of buying
a put butterfly for a $1 debit ($2
-
(2
.
$5) + $9 = $1).
The most which can be lost is the debit
price or cost
of the spread which, in this example, is $1. The
maximum profit is $4 which is obtained by taking 1/2
the difference between the two strikes minus the
price of the spread [(105 - 95)/2 - 1 = $4]. The
investor expects the
market to stay within a certain range when
purchasing a butterfly. Buying a butterfly has some
profit characteristics similar to selling a
straddle, without the unlimited risk associated with
selling the straddle.
An example
of
selling a butterfly is the sale
of the
June 95 call for $8, the purchase
of 2
June 100 calls for $5 each, and the
sale of the June 105
call for $3, for a $1 credit. The puts would follow
in the same order. The profit and
loss potential of selling the June 95,100, 105
butterfly for a $1 credit.
The most that can be made is $1, which is the amount received for
selling the spread. The most that can be lost is $4
if the market settles at 100 at expiration.
Therefore, the profit and loss potential is limited
when buying or selling a butterfly. The seller of a
butterfly expects the market to move away from the
center strike.
Backspreads and Butterflies
Option Strategy
