The Ratio spread is an options strategy in which an investor simultaneously holds an unequal number of long and short positions. While investing, a commonly used ratio is two short options for every option purchased. It can also be said that the ratio-spread is a strategy in options trading that involves buying some number of options and selling a larger number of other options of the same underlying market and the same expiration date, but of a different strike price.
It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.
Limited Profit Potential
Maximum gain for the call ratio spread is limited and is made when the underlying stock price at expiration is at the strike price of the options sold. At this price, both the written calls expire worthless while the long call expires in the money.
The formula for calculating maximum profit is given below:
- Max Profit = Strike Price of Short Call – Strike Price of Long Call + Net Premium Received – Commissions Paid
- Max Profit Achieved When Price of Underlying = Strike Price of Short Calls
Unlimited Upside Risk
Loss occurs when the stock price makes a strong move to the upside beyond the upper breakeven point. There is no limit to the maximum possible loss when implementing the call ratio spread strategy.
The formula for calculating loss is given below:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying > Strike Price of Short Calls + ((Strike Price of Short Call – Strike Price of Long Call + Net Premium Received) / Number of Uncovered Calls)
- Loss = Price of Underlying – Strike Price of Short Calls – Max Profit + Commissions Paid
