tldr: The call backspread ratio seems like a good play for stocks that may be ready to moon or to sink. It takes advantage of the current low volatility on the call side before an event. This allows unlimited room for profit should the underlying shoot up suddenly, while still limiting risk.
BASICS
## WHAT
A CALL RATIO BACKSPREAD is a more advanced strategy involving selling a vertical call spread and buying extra long calls.
It is a very bullish strategy that benefits from large upside moves and increasing volatility.
## WHO
This is not for AAPL or SPY. We are really only focusing on meme stocks before things get crazy. Or any stock that has the potential to moon in a short period. GḾE is the clear example. I theorize you could have run this basically at any point after the first fiasco before this recent pump, when things died down, and done fine, as long as you were managing it an rolling when needed.
## WHY
So why would you use this strategy over, say, a simpler one. Essentially you don't know what will happen with the stock. There is a lot of hype around it and maybe a lot of excitement on other particular subs. So you could sell puts, buy calls, buy stock and sell CCs, etc. I could go over the downsides of all of these on meme stocks but to put it simply, only one of those strategies has unlimited upside potential and none of them have no downside risk.
## WHEN
Put this on before things get crazy. You could not do this in GḾE currently and probably wouldn't want to do this for some other stocks that have had their day. I will get into this more in specifics.
## HOW
To setup this trade you SELL a VERTICAL SPREAD while buying another LONG CALL at the same strike as your VERTICAL LONG CALL. e.g. Stock is at 100 -> sell 1 CALL @ 110 strike & buy 2 CALLS @ 120 strike. That is a 1:2 ratio, but you could have any kind of ratio you want: 1:2, 1:3, 2:3, 5:8, etc.
SPECIFICS
## GREEKS
Delta: You don't need to worry about delta. We don't care about being delta positive, negative, or neutral here. You will not hedge deltas.
Theta: This trade should be put on for a small net credit. In theory that means it is theta positive. But in practice this is not so simple. Theta changes over time. If the stock stays in the same place for the entire trade it will go from negative to positive. But it can fluctuate between positive and negative depending on where you are on the graph.
Vega: Positive to neutral. Your profit line will sink into the valley when IV goes down, but the further into the valley you are, the higher the Vega. We want Vega to increase on the underlying.
## STRIKES
A lot of folks like to put their short strike right ATM. I'm not a fan of that for this case, since small upward drift will cause max loss on the position. I prefer much further out strikes. Further OTM strikes lessens the initial negative theta because the drag from the valley is less harsh. At least +10% from the underlying on our short strikes. Since we are looking for extreme upward moves, we want to avoid getting caught in the top of a consolidation or channel.
## DTE
A longer DTE > 60 days is my preference. By using a much longer dated expiration we can eliminate the noise of the stock and just focus on the moonshot. This also allows you to roll easier.
## CREDIT
The smaller the credit, the smaller max loss. The trade off being your possible ROC. I would try for about 6% of MAX RISK. Play around with the numbers to find what works for you.
## SKEW
This is one of the more important parts of the setup to this trade. You need to look at the structure of the options chain for the same DTE. We are looking for a normal volatility SKEW on the CALL side to take advantage of the low IV of out of the money calls. This strategy aims to catch a meme stock before take off. A high SKEW environment makes it impossible to put on for a credit, since it means OTM calls are much more expensive than normal. If we look at GḾE right now, you will not be able to put this on for a credit.
## VALLEY of DEATH
In the location between your chosen strikes is the "valley of death". The valley of death will drag your profit line down on the left side (downside) of the graph, before expiration. This is why I'm proposing this as a meme stock play. Slow grinds up are not your friend here.
## RISKS
If setup correctly for a NET CREDIT, there is NO DOWNSIDE RISK & LIMITED UPSIDE RISK. Your risk lies in the valley between your strikes and a little bit to the left of the valley before expiration. So your absolute risk in the trade is the width of the strikes minus the credit when you nail the absolute bottom of the valley.
PIN RISK is a real issue should the stock not moon and hover just inside the valley. So just be aware and plan to close or roll well before expiration.
## OTHER THINGS
You could also run a 2-2 1 which will cap your margin requirement and lower the valley of death to just a canyon of catastrophe. I kind of like this one better but it does require more contracts.
This could also be diagonalized to take advantage of a downward slop in the Term Structure.
## EXAMPLE
I just went over to WSB and looked for a DD. Found GNDR. It's the stupidest DD but it works as an example.
Vol SKEW for Aug 16th looks ok. And here is an example trade OptionStrat
Call Ratio Back Spread: The perfect strategy for meme stocks before they moon?
byu/1daBread inoptions
Posted by 1daBread
3 Comments
Interesting concept— thanks for posting. The trick with meme stonks (IMO) is that if you’re counting on a sharp upward move— you want to be uncapped. I love that about this structure.
Why 60 DTE? That’s 8 weeks. Wouldn’t safe, in the money debit spreads on something like AAPL net you 10% every week?
We are entering the worst months’ historical for growth. Plus, the market is more neutral right now. There are some bullish sectors like tech and communications.
We are seeing sector rotation to defense sectors all at the same time. Money is getting scared , and big money is going to finance, consumer defense, etc.
This is just how market cycles go around this time as sell in may is in.