What Is a Backspread?
A backspread is s a type of option trading plan in which a trader buys more call or put options than they sell. The backspread trading plan can focus on either call options or put options on a specific underlying investment. A backspread is a complex trading strategy with high risks that is typically only used by advanced traders.
How a Backspread Works
A backspread will generally be constructed as either a call backspread or a put backspread. A backspread can also be considered a type of ratio strategy since it will make unequal investments in two types of options. A backspread is the opposite of a frontspread in which a trader sells more options than they buy.
The term ratio spread helps a trader to illustrate and understand the ratio of a two-legged trading plan. A standard spread strategy occurs when an investor makes equal investment in both legs of the trading plan with a theoretical ratio of 1:1. Any spread strategy that does not invest equally in two legs of a trading plan is considered a ratio strategy with the ratio calculated based on the weightings of the investments.
A call backspread or call ratio backspread is constructed by selling (writing) fewer call options on an underlying security than are bought. A trader will typically sell call options and use the proceeds to buy call options on the same security. A call backspread is a bullish trading plan that seeks to gain from a rising underlying security value.
One example of a call backspread could consist of writing a call with a low strike price and simultaneously buying two call options of a higher strike price. In a call backspread all of the options will have the same expiration and underlying. (See also: The Basics of the Long Ratio Backspread)
A put backspread or put ratio backspread is constructed by selling (writing) fewer put options on an underlying security than are bought. A trader will typically sell put options and use the proceeds to buy put options on the same security. A put backspread is a bearish trading strategy that seeks to gain from a falling underlying security value.
For one example, a put backspread could consist of writing one put with a higher strike price and simultaneously buying two put options with a lower strike price. Backspreads will use option contracts that have the same expiration and underlying. Typically, they are constructed on a 2:1, 3:2 or 3:1 ratio.
A frontspread will deploy a trading plan in which a trader sells more contracts than they buy. Frontspreads are also constructed as either a call frontspread or a put frontspread.