The Backspread

Yahoo! (YHOO) has been rallying over the past few months, and sometimes makes me dizzy. I wonder how much further up it will go.  I currently have two bullish positions at much lower prices, but I'd like to hedge my bets by placing a short position on YHOO.  That may be foolhardy, so a nice technique might be the backspread.

Here is how it works.  The shorthand explanation is that you are shorting the stock, while giving yourself an opportunity to profit if it rallies.  We'll play with call options here.

YHOO is currently trading just about at $35 a share.  The October 2013 expiration is in 2 weeks.  If I believe that YHOO is due for a pullback from this point, I may wish to do a Bear Call Spread, whereby I buy the upper strike and sell the lower strike, as:

YHOO $35
Buy to open 10/2013 the 36 strike call option = $0.78 x $0.79 x7 contracts = ($553)
Sell to open 10/2013 the 35 strike call option = $1.16 x $1.17 x5 contracts = $580
CREDIT $27.00

Bear Call Spreads are normally credit spreads, and in fact, we are getting a credit.  However, for those familiar with the technique, you might wonder why the credit is so small.  That is because, in order to set up the possibility for profit if the stock continues to rally, we are long (bought) more contracts (7) at the higher strike than we sold.  The effect is that 2 of those 7 contracts are open to further rally, not covered or capped by the short (sold) 35 strike calls.

POSSIBLE OUTCOMES:  If YHOO continues to rally, and rallies sufficiently in the next two weeks to cover the time decay of the 36 strike calls, those calls will increase in value.  Again, please note that the current price of those calls ($0.78 x $0.79) is entirely time value that will very quickly erode as we approach expiry in two weeks.  If, as I expected when I placed this trade, the stock pulls back a tad, to under the 35 strike, my Bear Call Spread will be profitable to the tune of $1.00 (36-35=1).

What's the absolute worst scenario? That YHOO closes between the two strikes, and unless you are fleet-footed, you might not be able to salvage any part of the position.  For your troubles, you'll still make $27.00. 

I would welcome your input, especially if there is any flaw in my reasoning.