Call back spreads
are ideal when you are expecting big moves in already volatile stocks. The
strategy involves selling a call at a lower strike price, then buying a greater
number of calls at a higher strike price. It is best conducted for a minimal
debit or small credit, so if the stock drops you wont suffer either way. But, if
the stock rallies you will have unlimited potential profits as you hold more
long calls than short. To maximize the profit traders often use in the money
options as they have a higher likelihood of finishing in the money.
Example:
Using IBM we can create an in the money call back spread. In this case
you might buy two $85 Calls at $1.05 and sell one $80 Call for $4.00.
You
would receive $190 ($4 – $2.10) x 100 shares) for entering the trade. If the
stock drops below $80 you keep the $190. But the real money is made if the stock
rallies; the break-even point of the trade is $88.10, at this price the $80
Calls are worth $8.10, while the $85 Calls are worth $6.20 (2 x $3.10). Above
$88.10 the profit potential is unlimited.
Using ShareCharts
Option Strategies for Call Back Spreads the entire transaction can be seen
clearly. Go to Derivatives < Option Strategies and select Call Back Spread
from the ‘Strategy’ Drop Down Box. Enter in all relevant parameters and
click ‘Update’ to view the chart.