Backspread, What is it and How to Use it

The Backspread is an option strategy that attempts to profit by buying and selling a certain number of the same options. This spread can either be done with all calls or with all puts.

The Put Backspread

This spread attempts to make money as the stock goes down by selling 1 put and buying 2 puts with a lower strike price.Take for Example XLF, it is trading at $10.34 and we expect it to go down in the short term.

We decide to enter this trade buy selling 1 $11 put for $.82 and buying 2 $8 puts for $.36 each or $.72 total. The difference for what we sold the $11 put for and what we bought the $8 put for is $.10, so that is our initial credit.

If the stock goes above $11 we keep the $.10 profit and everything else expires worthless. The real profit would come if the stock falls fast. If the stock falls past $8 we would profit from the two puts we bought, but lose from the one put we sold.

In order for us to profit the stock would need to get below the breakeven point, which you can find with this formula.

Downside Breakeven = Long Strike Price – (Short Strike Price-Long Strike Price) +Credit per trade (or – Debit from trade)

So in our example the formula would look like.8-(11-8) +.1 which would give us $5.1, which means the stock would have to drop below $5.1 for us to make money on the downside.

The Call Backspread

When you use calls you try to make money as the stock goes up. So, in this example we are going to use XLF and instead of using puts we use calls.

We sell 1 $10 call for $1.01 and buy 2 $13 calls for $.30 each or $.60 total. Our initial credit from this trade is $.41.

If the stock goes below $10 every option expires worthless and we keep the $.41 profit, but the real money comes if the stock makes a big move to the upside.

If the stock gets past a certain point we would start to become profitable. The breakeven point can be found through this formula.

Upside Breakeven = Long Strike Price – (Long Stroke price – short strike price)–net credit (or plus net debit)

So in our example the formula would look like this.13+ (13-10)-.41 which would give us $15.59.

The stock would have to go above $15.59 for us to be profitable on the upside.