Ratio Backspreads
Ratio Backspreads are used by traders when they think a big move will occur. Usually buying a further month ratio backspread is mentioned. While this gives you more time it also makes you widen the strikes between the options you buy and the options you sell. Or, you have to pay more of course.
If you wanted to put on a ratio backspread, you might want to have more time to be correct but you also want to have the purchased options strike price to be as close to the sold options strike as possible.
This is so the purchased options will get in the money quicker. If you feel the market will move a lot higher or lower in a short amount of time, start thinking of buying a close month ratio backspread. Yes, you have less time, but the strike prices of the options will be closer and you will need less of a move.
Please use this for educational purposes.
February Gold closed at 807.1. January options follow the Feb. futures contract. Jan. Gold 810.0 Call options closed at 14.60. Jan. Gold 830.0 Call options closed at 7.70.
If you felt that this market was going higher fast, you can sell 1 Jan. 810 Call and buy 2 Jan. 830 call options for even money. There is limited risk but unlimited profit potential.
I am not giving advice on what to do in this market right now. I am just trying to show you a reason why you should start looking at the closer months when choosing to put on a ratio backspread.
To recap, the further months will give you more time to be correct but you will have to pay more to put on a ratio backspread. Or, you will have to buy the options that are further away from the money. In that case, you would need a bigger move to be profitable.
David has traded futures & options for one of the largest cash trading firms in the world. He currently owns and runs the following websites:
Futures Options Simulated trading
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