Backspread (Securities Trading) - Definition
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Backspread Ratio (Securities Trading) Definition
A ratio spread is a strategy used by traders to understand the ratio of an underlying trading plan or two-legged trading plan. This strategy is commonly used in options, it entails the purchase of a number of stocks and selling more of the same options at a different strike price but at the same expiration date. A spread strategy used by an investor in which an equal investment is made in both legs of the two-legged trading plan is a standard spread strategy. Any other strategy that does not invest equally is not a standard spread, it is called a ratio spread. A standard spread often has a ratio of 1:1 while a ratio spread is estimated based on the weight of the investment.
Call Backspread Ratio
A call backspread is a strategy used in a bull market in which fewer call options are sold in an underlying security but more call options are purchased under the same expiration date of the underlying security but at a higher price. A call backspread is also referred to as a call ratio backspread, it is a strategy or trading plan used in bullish markets. This strategy offers unlimited profits and minimal risks to traders. Traders sell call options with low strike price and purchase call options with higher strike price in the same underlying security and expiration date.
A put backspread entails trading a number of put options and buying more put options that what is sold in an underlying security. It is also called a put ratio backspread, it is a bearish strategy in options trading. The proceeds that a trader makes from selling a number of put options would be used in purchasing higher number of put options on the same underlying security. The expiration date of the underlying security is also retained. The ratio for put ratio backspreads are often constructed as 2:1, 3:2 or 3:1.
A front spread is the reverse or opposite of a backspread. It is a trading strategy where a trader sells more and buys less unlike in a backspread scenario where less is sold to buy more. A frontspread is also a two-legged trading plan or multi-led option strategy where a trader buys one call option on an underlying and sells two call or put options on the same underlying security and expiration date but at a different strike price.
Reference for Backspread
- https://www.investopedia.com Investing Options
Academics Research on Backspread
- Backspreadpayoff profile, LINE, B. (2005). Backspread payoff profile.