9 Weeks to Better Options Trading: Back Spreads
Veteran options trader Steve Smith breaks down the back spread.
Let’s look at the worst-case scenario in the Google example above. If shares stabilized around the $625 level, and implied volatility continued the typical post-earnings decline, the position would be worth around a $7 net debit, for a $9 or 56% loss. If it were to be stubbornly held until the May expiration and shares were right at $600, the loss would be a whopping $32 -- far more than the initial $16 outflow.
This type of risk creates a dilemma: Back spreads can usually be established on a more attractive ratio closer to expiration as the further out-of-the-money option becomes less expensive. But holding a back spread until expiration increases the chances it will land in the dead zone and incur a loss.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.