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Call Ratio Spread
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| Risk: |
Limited |
| Reward: |
Unlimited |
| The Trade: |
The trade itself involves selling a call (normally at the money or near to the money) at a lower strike and buying a greater number of calls at a higher strike price. Depending on the strikes chosen, the position can be established for free or at a small cost. |
ABC Stock trading at £5.00
Sell 1 Sep £5.00 call (A), buy 2 Jun £5.50 calls (B) (see pay-off diagram below)
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| When to use: |
For bullish investors who expect big moves in already volatile stocks/indexes, call back spreads are a great limited risk, unlimited reward strategy |
| Volatility expectation: |
Bullish, you want to see volatility levels keep at least stable, but preferably rise. |
| Profit: |
Unlimited if underlying rallies. |
| Loss: |
Limited. Greatest loss occurs at higher strike which is the difference between strikes minus (plus) net credit (debit). |
| Breakeven: |
Lower break-even point is reached when the underlying exceeds the lower strike option by the same amount as the net credit received. But if the initial position is established at a net cost there is no lower break-even point. Higher break-even point reached when intrinsic value of the lower strike is equal to the intrinsic value of the two higher strike options plus (minus) the net credit (debit). |
| Time decay: |
Hurts but not too much |
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Trading ideas and tactics:
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- Can use other ratios 2 by 3 for example - sell 2 calls and buy 3 calls
- Try and put on as near to zero price as possible, then good downside protection
- Good trade to use when market has been rallying but has stalled into a trading range, and you expect a further breakout to the upside
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