Explort Your Options  |  SEP 2003

Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile RATIO BACKSPREAD Could you please explain what a ratio backspread is? —David BJ A ratio backspread is a delta-neutral strategy that is directional in nature, and allows the trader to enter the position with a zero debit or credit (margin is required). The trade is designed to profit from a large move in the underlying but lose little or nothing should the underlying move in the opposite of the intended direction. Generally, the trade is set up when the implied volatility of the underlying options is low, and more options are purchased than sold. The idea is that the options you sell should pay for all of the long options. The most common ratios are one option sold for every two bought, or two sold for three bought (known as 1x2 and 2x3 ratios, respectively). Of course, you can have any ratio you want, but the math becomes complex, and your ability to generate a sufficient profit to justify the ratio becomes questionable with higher ratios.

by Tom Gentile