call back spreads using LEAPS for long term market comeback?

Discussion in 'Options' started by buwatcha, Oct 26, 2008.

  1. buwatcha


    Hi all-

    I'm a newb and am looking for some thoughts on this strategy:

    Assuming that the market will signifcantly rebound over the next two years:

    I'm thinking about using call back spreads with LEAPS to self finance positions (sell one call to pay for two higher strike price calls) that are likely to end up DITM in two years if the market comes back. I want to use LEAPS to give the market time to turn around.

  2. If you really expect a big move, it's easier to simply buy calls. If looking for a higher probability trade, but with less reward, consider selling put spreads.

    Back-spreads are usually an attempt to profit by owning <b>gamma</b>. LEAPS options have less gamma than their nearer-term counterparts.

    You must be careful with these spreads because it's possible to lose a significant amount if you hold for a long time and the underlying moves to a bad spot.

    One final problem: LEAPS have lots of vega, and not gamma. Option prices are very high right now - due to explosive market volatility. Because it's almost a guarantee than IV (implied volatility) will be much lower in the future, buying options loaded with vega is probably not a great idea.

    Maybe you can simply buy call spreads or sell put spreads to accept a limited profit - but which saves you from the risk of owning too much vega.

    If you know how to use an option pricing model (I know you are a rookie) take a look at one year's time passage and a 50% drop in IV. That may scare you out of the LEAPS back-spread.