What is a back spread with calls?
A back spread with calls is an options strategy that is created when you sell a short call option that is in-the-money and purchase two out-of-the-money long call options. The long calls will have the same strike price. All three call options have the same expiration date.
There are two ways to open a back spread with calls: for a debit or for a credit. Nevertheless, a back spread with calls is typically opened for a credit.
When to use a back spread with calls strategy
When an investor is bullish on a stock and believes the price will go up, a back spread with calls can be a suitable position. This strategy consists of buying a higher number of calls with a lower strike price, and selling a lower number of calls with a higher strike price. This way, the potential profit remains unlimited as long as the underlying asset's price trades above the long call strike prices at expiration.
If you are expecting the price of the underlying stock to rise only by a little bit, then you’ll want to avoid using this strategy. That scenario represents the worst outcome for a back spread with calls. This is because the risk is limited if the stock price decreases a lot.
How to manage a back spread with calls position
How time decay impacts the value of your position depends on where the underlying stock trades relative to the strike prices and whether or not you've initiated the strategy for a net credit or debit.
If you establish a net credit, time decay will reduce the value of your position if the stock trades at or above the lower strike. This is because it will eat away at the value of your two long calls more than the short call. If the stock trades at or around the higher strike, time decay will inflict the most pain. This is because that is where your maximum loss will occur at expiration.
If the underlying stock falls below the higher strike price, you will benefit from time decay. Ideally all of the options expire worthless so you can collect your credit.
If you establish a net debit strategy, time decay can be a problem. This is because it erodes the value of your two long calls more than the value of the short one.
Back spread with calls maximum profit potential
There is theoretically an unlimited profit potential when you take on a back spread with calls position.
Back spread with calls maximum loss potential
The potential risk is limited to the difference between the higher and lower strike prices, minus the net credit received or plus the net debit paid.