SPY Back Ratio Spreads and Why We Have Been Trading
We have been putting on a few SPY Call Back Ratio trades. Here I will explain why.
What is a back ration spread?
A 1x2 ratio spread with calls is created by selling one lower-strike call and buying two higher-strike calls. This strategy can be established for either a net credit (as seen in the example) or for a net debit, depending on the time to expiration, the percentage distance between the strike prices and the level of volatility.
The further out you take the trade the more likely it is you will need to pay a debit, which gives you zero downside risk protection. What we have been doing is a few weeks out, to take on a credit with this market condition. That way, if the market decides to dump off, we will collect 100% of the credit received and have full downside protection. This also gives you unlimited profit potential to the upside. In the below example you woud be able to close the trade out as the market started to climb over $295 for a nice profit. Your max loss occurs between the two strikes. In the example below we had a max risk of $575 per lot if the market stayed flat between $290 and $295 going into the June 3rd expiration.
Our recent trade we opened on May 16th:
June 3rd expiration
STO (1) SPY 290 calls
BTO SPY (2) 295 calls for a net credit of 1.45 per lot
This gave us full downside protection on the trade if SPY traded below 290 for a period of time. We were able to close out this trade and collect our downside protection already.
What it looks like:
In very choppy markets like we have been in recently these trades can give you a huge advantage over long calls or puts, you don’t need to guess which direction the market is going to go but instead take the bet that the market will remain volatile and not stagnant.
We have a few more of these trades on that are working together to create a nice income for us while the market is trying to find a direction.