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When to do it
This strategy works best when the trader thinks that the pair is bearish with high volatility.
- Sell an ATM Put at strike price B (spot +0 )
- Buy an OTM Put at twice the amount of B at strike price A (spot - )
- At the time of creating this strategy, the pair’s price will be at B.
Maximum potential profit
The maximum potential profit can be very substantial if the pair’s price decreases by a big amount.
Maximum potential loss
The maximum potential loss is limited to the difference between B and A minus the premium received.
In the Back Spread with Puts strategy, time decay will inflict the greatest loss if the pair’s price is at A. If the pair’s price is at or above B then time decay works in favour of the trader in order for both options to expire worthless and the trader will profit from the premium received.
Best/worst case scenario
The best case scenario occurs when the pair’s price decreases by a big margin. Profits keep rising as the pair’s price decreases. The worst case scenario occurs when the pair’s price does not decrease as much as expected and the trader suffers the greatest loss at A.
By increasing the price of the Put purchase, maximum profit is increased. The point where the premium received is close to 0 is where the trader can earn a big profit and at the same time does not suffer a loss if the pair ends up being bullish. Any occasion where the trader is required to pay a premium instead of receiving a premium would mean higher profits if the pair is bearish but losses if the pair is either bullish or not as bearish as expected.