Disney Stock and the Ratio Backspread

March 8, 2010

In a recent post, we wrote about using options on Corn futures to take advantage of a directional move using a combination of puts and calls.  The related post can be found here.

This time, we will look at Walt Disney shares, which at the time of this writing, are trading at or near $33/share.  We will look at a variation of the ratio back spread that provides unlimited upside potential and limited risk.  But, we will modify the trade slightly, compared to the traditionally ratio backspread.

Typically, the ratio backspread involves owning more options than being short options, of the same month and market.  The normal ratio is two to one.  We we keep the ratio the same in this example, however we will be using three strike prices.  The normal ratio backspread uses two strike prices.

You will see via the graphical depiction that, by using three strike prices, we can make money if the market moves up; but, with the trade structured using three strikes, we can also make money if Disney share price falls significantly.

In the example, we are long 20 April Disney call options at a strike price of 34, short 5 April Disney call options at a strike price of 33 and short 5 more April Disney Call options at a strike price of 32.

The ratio of the position is still two to one, however the major difference is the usage of three strike prices rather than two.  Doing so, in some cases, can result in profit if the market trades higher or lower.

In summary, this variation of the ratio backspread, using call options for Disney shares, using three strike prices, keeps the ratio at two to one (we are long more options than the ones we are short) and we have unlimited upside potential, defined maximum loss and the potential to make money if Disney shares break sharply.

Disney ratio backspread

Disney - Ratio backspread

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