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Put Back Spreads |
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Put back spreads are wonderful strategies for when an investor is expecting big downward moves in already volatile stocks. The trade itself involves selling a put at a higher strike and buying a greater number of puts at a lower strike price.
Ideally, this trade will be started with a minimal debit or possibly even a small credit. In that way should the stock gain ground, the investor won't suffer much either way. However, should the stock drop as the investor expects, the profit potential is significant because the investor will have more long than short puts. To maximize this position, many traders use in-the-money options because they have a higher likelihood of finishing in-the-money.
For example: Utilizing Dell, an investor creates a put backspread by using in-the-money options. With Dell trading at $30 in April, the investor buys two of the May 30 puts at $1.25 and sell one May 32.5 put at $2.70. The trader receives $20 for putting on the trade, and if the stock jumps above 30, the investor would profit $20. However, the real money is when the stock makes a big move to the downside. The downside breakeven for this trade is 27.50. At this price, the 30 puts would be worth $2.50 while the 32.5 puts would be worth $5. Below $27.50 the profit potential increases dramatically.
The simplest way to calculate the downside breakeven is by using the following formula:
Downside Breakeven = Long strike price - [(Long strike - short strike) # of short contracts] + net credit/100 (or - net debit)
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| Symbol |
Rate |
| GBP:CHF |
1.747703 |
| GBP:JPY |
155.484239 |
| GBP:USD |
1.638403 |
| NZD:USD |
0.627050 |
| EUR:CAD |
1.545998 |
| EUR:CHF |
1.516857 |
| EUR:GBP |
0.867915 |
| EUR:JPY |
134.947096 |
| EUR:USD |
1.421994 |
| AUD:JPY |
76.394373 |
| AUD:USD |
0.805000 |
| USD:CAD |
1.087204 |
| USD:CHF |
1.066711 |
| USD:JPY |
94.899879 |
| USD:SEK |
7.613010 |
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Disclimer: This website is for informational purposes only and is not intended to provide
specific commercial, financial, investment, accounting, tax, or legal advice.
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© ForexCenter.com, 2005, All Rights Reserved
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