Ratio spreads with options

The spread ratio is a ratio between the number of options long and the number of options short in a spread (link) that is other than one. For example, you buy 1 in-the-money call and you write 2 or more out-of-the-money calls.

General

The Ratiospread is neutral, in other words you do not expect a large increase or decrease. Naturally, these can be entered into with both calls and puts.

Ratio call spread

The call spread ratio is derived from the call (bull) spread, where you buy one call and sell one call with a higher strike price. You then turn this into a ratio call spread by selling two or more calls with the higher strike price.

Example

Suppose the price of the underlying stock is 52, the premium of an October 50 call is 3.00 and the premium of an October 55 call is 1.50. A 1:2 ratio call spread can now be entered into by buying 1 October 50 call and selling 2 October 55 calls. On balance it costs you nothing (except the costs) , but you also receive nothing. We call this an even money spread. However, there is a margin requirement because of the uncovered October 55 calls. The maximum profit at the expiration date is reached at a price of 55. The October 50 calls are then worth 500 and the October 55 calls then expire worthless. The break-even point of this construction is at a price of 60. Above that, a loss is (only) incurred, albeit unlimited. Below 55 the profit runs linearly to 0, at a price of 50. Below that it remains 0, because all calls of course expire worthless. So there is no risk of decline.

Ratio put spread

We will explain the put spread ratio using an example . Suppose the share price is 54, the premium of the October 55 put is 3.50 and the premium of the October 50 put is 1.00. With a put spread ratio of 1:2, the investment now becomes 1 October 55 put (3.50), plus 2 October 50 puts (2.00), a total of 1.50. The maximum profit is at a price on expiry date of 50 and then amounts to 350. Above 55, all puts expire worthless and the investment is lost. So this is the maximum loss on that side. Above 53.50 you will therefore lose up to a maximum of the investment. Below 46.50 you will also lose, in principle until the value of the share is 0.