Innovated Tips from Better Trades

For bullish investors who expect big moves in already volatile stocks, call back spreads are a great limited risk, unlimited reward strategy. 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.

Example	Increase in Volatility	Time Erosion
Sell Calls (lower strike) Buy Calls (higher strike)	helps position	hurts position

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. Using XYZ, a company that historically has been quite volatile, we can create a ratio backspread using in-the-money options.

Strike Price	Call Price
Stock Price	$25.50
August 22.5 Call	$4.50
August 25.0 Call	$2.50

In this case, you might sell two of the 22.50 calls at 4.50 and buy three 25.0 calls at 2.50.

Sell two 22.5 Calls @ $4.50 for a credit of $9.00

Buy three 25.0 calls @ 2.50 for a debit of $7.50 Position would net a credit of $1.50 (9.00 - 7.50)

In this case, you would receive $150 ((9.00 - 7.50) x 100 shares) for putting on the trade. If the stock dropped below $22.50, you would keep the $150. 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 $28.50 ($3/share higher than its current price). At this price, the two 22.5 calls would be worth $1,200 (600 x 2) each while the three 25 calls would be worth $1,050 (350 x 3). Factoring in the initial $150 credit, the ROI at this price would be 0. Above $28.50, the profit potential is unlimited.

Values at Expiration

Stock Price	Two 22.50 calls (sold)	Three 25.0 calls (bought)	Original Credit (Debit)	Total Profit (Loss)
20	0	0	150	150
22	0	0	150	150
23	(100)	0	150	50
24	(300)	0	150	(150)
25	(500)	0	150	(350)
26	(700)	300	150	(250)
27	(900)	600	150	(150)
28	(1,100)	900	150	(50)
28.50	(1,200)	1,050	150	0
29.00	(1,300)	1,200	150	50
30.00	(1,500)	1,500	150	150
35.00	(2,500)	3,000	150	650

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:

(25 + [(25 - 22.5) x 2] - (150/100)

Simplified, the equation becomes:

(25 + 5 - 1.50) = 28.5

The maximum loss for this trade would occur with the stock at 25 because the long calls would be worthless and the two short calls would be worth $250 each. Factoring in the initial credit of $150, the maximum loss on this trade would be $350 (2 contacts x $2.50 x 100 shares - $150 credit).