Call Ratio Spread
ratio call spread
 Details
 Category: nonsynthetic futures and option strategies
 Published on Wednesday, 17 February 2010 22:50
call ratio spread
the ratio spread is a neutral strategy in options trading that involves buying a number of options and selling more options of the same underlying stock and expiration date at 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.
ratio spread construction

buy 1 atthe money call

sell 2 out the money calls

call ratio spread
using calls, a 2:1 call ratio spread can be implemented by buying a number of calls at a lower strike and selling twice the number of calls at a higher strike.
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 beakeven 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
little or no downside risk
any risk to the downside for the call ratio spread is limited to the debit taken to put on the spread (if any). there may even be a profit if a credit is received when putting on the spread.
breakeven point(s)
there are 2 breakeven points for the ratio spread position. the breakeven points can be calculated using the following formulae.
 upper breakeven point = strike price of short calls + (points of maximum profit / number of uncovered calls)
 lower breakeven point = strike price of long call +/ net premium paid or received
using the graph shown earlier, since the maximum profit is $500, points of maximum profit is therefore equals to 5. adding this to the higher strike of $45, we can calculate the breakeven point to be $50. (see example below)
example
suppose xyz stock is trading at $43 in june. an options trader executes a 2:1 ratio call spread strategy by buying a jul 40 call for $400 and selling two jul 45 calls for $200 each. the net debit/credit taken to enter the trade is zero.
on expiration in july, if xyz stock is trading at $45, both the jul 45 calls expire worthless while the long jul 40 call expires in the money with $500 in intrinsic value. selling or exercising this long call will give the options trader his maximum profit of $500.
if xyz stock rallies and is trading at $50 on expiration in july, all the options will expire in the money but because the trader has written more calls than he has bought, he will need to buy back the written calls which have increased in value. each jul 45 call written is now worth $500. however, his long jul 40 call is worth $1000 and is just enough to offset the losses from the written calls. therefore, he achieves breakeven at $50.
beyond $50 though, there will be no limit to the loss possible. for example, at $60, each written jul 45 call will be worth $1500 while his single long jul 40 call is only worth $2000, resulting in a loss of $1000.
however, there is no downside risk to this trade. if the stock price had dropped to $40 or below at expiration, all the options involved will expire worthless. since the net debit to put on this trade is zero, there is no resulting loss.
note: while we have covered the use of this strategy with reference to stock options, the ratio spread is equally applicable using etf options, index options as well as options on futures.
commissions
for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
however, for active traders, commissions can eat up a sizable portion of their profits in the long run. if you trade options actively, it is wise to look for a low commissions broker. traders who trade large number of contracts in each trade should check out optionshouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).
Non Synthetic Positions

Long Call Butterfly

Long Futures Position

Short Futures Position

Long Call

Short Call

Bear Spread (call & put)

Bull Spread (call & put)

Long Put

Short Put

Long Straddle

Short Straddle

Long Strangle

Short Strangle

Call Ratio Spread

Put Ratio Spread

Call

Call Ratio Backspread

Put Ratio Backspread

Long Put Butterfly

Short Butterfly

Box Or Conversion/Reversal
Please be aware that trading futures and options involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future results.
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