The call backspread option strategy is a surprisingly uncommon option strategy that will allow us to obtain profits when the underlying price goes either up or down for a certain period of time.

In this guide, we will discuss the call backspread option strategy. We will learn how to use it in our favor and how to spot the call backspread risks and profits with our option strategy builder calculator.

What is a call backspread option strategy?

The call backspread option strategy is a multidirectional strategy with a stronger bullish perspective, unlike the put backspread, which is a bearish one.

The call backspread allows us to make some limited profits when the underlying price drops under a certain threshold. At the same time, if the stock price of the asset begins to gain more and more value, our profits are unlimited, just like in the case of a long call option.

However, the only scenario where the strategy will lose money is when the stock price stagnates between the two strike prices of our strategy. The good news is the call backspread risk is completely limited, as we will learn later.

How is a call backspread option strategy composed?

In order to create the call backspread option strategy and to profit from it, the most typical approach is to sell an At The Money call option while at the same time buying two Out of The Money call options.

The objective is this: we need to receive a credit for the sold call, and that credit should pay the two Out of The Money call options we bought and leave us with some profit for just opening the call backspread.

Configuring the call backspread option strategy in this way, we are limiting the profits to the downside, while we are making them unlimited to the upside.

When to use the call backspread option strategy?

The call backspread option strategy is better used when we are certain that there is going to be a movement in the asset we are dealing with, and we believe it is going to be to the upside.

To make better use of the strategy, we could use a technical analysis tool just like the stochastic indicator to jump into an active trend and take the best from it.

With the call backspread, we are covering both sides of the market, just like a long strangle or a long straddle would do, but with a lower risk and a more bullish perspective.

The best way to understand how the call backspread risk and profits work is with an example over a real underlying.

Call backspread option strategy example

Let us suppose we want to trade a call backspread option strategy over the SPY, which is the ETF that replicates the behavior of the S&P500 index. As the United States elections are coming the next week, we are not very sure about what is going to happen in the market in the next 15 days.

What we know is that there is going to be a high volatility that could lead the market to either go down or go up. So, to take part in this move, if we somewhat believed that the stock market is going to rise, we could open this call backspread option strategy because we would be covering the risk to the downside.

In this case, as the SPY stock price is today at $323.66, what we are going to do is to sell an At The Money call option contract whose strike price is $324 while, at the same time, buying two Out of The Money call options whose strike prices are $336. We are going to assume a volatility of about 33% in both cases to simplify the matter.

Let us take a look now at the call backspread calculator to learn the result of opening this trade.

In this case, the call backspread calculator is showing us the values of the legs. For the call option contract we sold, we will receive $8.26 as a net income. However, for the Out of The Money call options we bought, we will have to pay $3.77 each.

In other words, if we subtract what we paid from what we received, we will find a total net income of $0.73. Now, we should take a look at the SPY chart to understand what is happening in this situation

Breaking down the call backspread option strategy

In the previous image, it is represented the call backspread option strategy. The green lines are the strike prices of our call options.

As we can see, the green area of the chart represents the zones in which we would be making profits. If the SPY falls below $324, the maximum profit we would make would be $0.73, which is the remaining credit we had.

Simultaneously, if the SPY rises above $347, our long call options will begin to make some profits, and those are unlimited.

However, if the stock price stays in the red zone, we would produce a loss, but this is not very likely, as we have already determined.

To fully understand the call backspread risks, the best thing to do is to show the payoff diagram of this strategy.

Call backspread risks, payoff diagram

To represent the diagram, we have used our call backspread calculator, in which we will be able to see the expected results at the expiration date.

As you can see in the call backspread calculator, we have a limited profit of $0.73 if the stock falls under the $324 mark and an unlimited profit to the upside.

If the underlying stays between these two areas when the expiration date arrives, the call backspread risk becomes higher. The maximum loss we can obtain in this case is when the stock ends up at $366, in which we would lose $10.27.

Call backspread option strategy margin requirement

As with any other option strategies that have a short-selling leg, the call backspread will also require a margin by the broker. In other words, we are going to need a margin account to be able to execute this trade.

In order to calculate this value, the only thing we need to know is the differences between the strike prices of our strategy.

Following the example of the SPY trade, as we were dealing with a short call option whose strike price was $324 and with another long call option whose strike price was $336, the margin requirement would be the difference between these two prices multiplied by one hundred

In other words, the margin requirement of the call backspread in this case is $1200. If we do not have that amount in our account, the broker will not allow us to perform the trade, so we will need to reduce the margin by picking another strike in the option chains.

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Last words about the call backspread option strategy

The call backspread option strategy is a multidirectional option trading strategy that will allow us to make money whenever the market moves.

We should always keep in mind to open the trade and make some net income in order for the strategy to work as intended and make the best of it.