The backspread trade is used to take advantage of large moves (up or down) in the price of a stock or index. A backspread trade consists of more long options than short options with the strike prices selected so that the cost of the spread is small and even sometimes can be initiated for a credit.
The main drawback to a backspread trade is that it returns a significant profit only for large moves in the underlying stock or index. In fact, the spread incurs its maximum loss when the stock or index has achieved only a modest move in price at the option’s expiration date.
Let’s begin by looking at a typical example of a bullish backspread trade:
Example 1. In February, XYZ stock is at $19, and you feel that this stock has ...