Key points
- A bullish call backspread limits maximum risk without limiting maximum gains.
- A bullish call backspread strategy can be used when you are very bullish on a stock and expect a sharp upward move.
- This is a multi-leg strategy consisting of a 1:2 ratio, selling 1 ATM or ITM call and buying 2 OTM calls.
- 5 stocks we prefer to Intel’s
Options trading strategies such as call debit spreads can be used to help mitigate potential losses in exchange for limiting potential upside gains. They also allow you to enter a bullish directional trade at a discount compared to simply purchasing a long call option. A debt spread allows you to quantify maximum risk and reward, while reducing the cost of a long directional trade on the underlying security. The long call is partially funded by selling the call in the month (ITM).
If you are very bullish on a stock and are willing to pay a little more to remove the upside cap, then you may want to consider a the bull calls backspread strategy. It works on any option stock in any stock sector of the stock market.
The mechanisms of the bull’s return
This strategy is also called call backspread, call ratio spread or ratio spread. The mechanics are similar, inserting a short call spread to offset the purchase of a long call. This is a two-legged strategy.
Sell 1 at-the-money (ATM) or in-the-money (ITM) call and buy 2 out-of-the-money (OTM) calls.
Analyzing the INTC daily candlestick chart setup
We use semiconductor giant Intel Co. NASDAQ: INTC as an example. Let’s say we are very bullish on INTC due to the artificial intelligence (AI) trend and an upcoming AI industry conference where the spotlight will be on AI chip makers.
INTC trades at $44.99 on March 12, 2024. After the earnings sell-off, INTC attempted to make higher lows and higher highs. This could result in a cup pattern forming during a rally towards the swing high $50.15. The daily relative strength index is forming a divergence bottom where every rebound attempt occurs in a higher range.
Put on the market
The trigger would be breaking above the 60 band to unlock the bullish momentum. We select the expiration date of April 12, 2024, giving us 31 days until expiration. We will place the $45/$46 backspread call on INTC. Since the $45 strike is at-the-money (ATM) and the $46 strike call option is out-of-the-money (OTM), these are the most formidable strikes to play for the call backspread.
To execute the backspread call strategy, we sell 1 $45 call at $2.05 and buy 2 $46 calls at $1.68. The first short $45 call results in a $205 credit. The 2 long $46 calls cost $336. The net cost of this trade is $1.31 or $131.
It is important to have a strong setup or the potential for a strong breakout with the call backspread. The stock needs to rise more than the strike price of the 2 long calls.
Possible outcomes of the Bull Call Backspread
Here are the possible outcomes if the call backspread is held until expiration on April 12, 2024, based on INTC’s closing price.
If INTC closes at $50, the short INTC $45 call is worth -$500 less the $205 premium received for a loss of -$295. The long $46 calls are worth $4 each or $800 total less the cost of the $336 trade is a profit of $464 minus the -$295 loss on the short call for a net profit of $169 or a gain of 129%.
Self INTC closes at $48, the short INTC $45 call is worth -$300 minus the $205 premium is -$95. The 2 INTC 46 calls are worth $2 each for a total of $400 less the cost of $338 for a profit of $62 less the loss of -$95 resulting in a net loss of $33 or loss of 25.2%. The breakeven price is an INTC close at $48.33.
Self INTC closes at $47, the loss is the cost of the trade – $131 is taken.
Self INTC closes at $46, the loss is the cost of the trade -$131 and the spread of $1 for a maximum loss of $231.
Self INTC closes at $45 or lessTHE the maximum loss is the trade cost of $131.
Best use cases and when to avoid Bull Call Backspreads
Bullish call backspreads are ideal in volatile stocks and markets. A rapid price increase is preferable as an increase in implied volatility can increase premiums on long calls, even if they are out of the money. While we use the example of waiting until the options expire on April 12, 2024, we can choose to close the position at any time. If the INTC increases and volatility increases, the rewards can add up.
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