Home > Options Strategies > Ratio Spreads

 Ratio spread is simply a way of classifying options strategies that buys and sells an unequal number of contracts simultaneously. Knowing or not knowing such classification does not actually affect your options trading in anyway.

Vertical Ratio Spreads are the most common type of ratio spreads and are commonly known as Call Ratio Spreads or Put Ratio Spreads. These spreads, also known as Bull Ratio Spread and Bear Ratio Spread, are simply call and put vertical spreads that sells more short options than long options are bought.

Horizontal Ratio Spreads, also known as Calendar Ratio Spreads, are horizontal spreads that shorts more near term options than long term options are bought so that the position is established for free or for a net credit.

Diagonal Ratio Spreads, also classified as Calendar Ratio Spreads, are diagonal spreads that shorts more near term options than long term options are bought so that the position is established for free or for a net credit. There are two main Diagonal Ratio Spreads and they are Call Diagonal Ratio Spread and Put Diagonal Ratio Spread.

The basic aim of Ratio Spreads is to eliminate upfront payment for the long options or even transform debit horizontal, vertical or diagonal spread positions into credit spread options trading positions so that the position makes money even when the stock should go into the wrong direction.

When Ratio spreads are put on for a net credit, they become options trading positions that profit 3 ways; When the underlying stock is stagnant, when the underlying stock moves in the favorable direction slightly and when the underlying stock moves in the disfavorable direction strongly. This is almost as good as profiting no matter what happens and covers the directional weakness in horizontal, verical and diagonal spreads.

 Vertical Ratio Call Spread Example : Assuming the QQQQ is trading at \$44 and its Jan44Calls are bidding for \$1.30 while the QQQQ Jan46Calls are asking for \$0.30. A 5 : 1 vertical ratio call spread is set up for a net credit by buying 1 contract of Jan44Calls and shorting 5 contracts of Jan46Calls. Net credit = (\$0.30 x 5) - \$1.30 = \$1.50 - \$1.30 = \$0.20 When QQQQ rises to \$46, the Jan44Calls will be worth \$2.00 while the Jan46Calls expire, producing a profit of \$2.00 + \$1.50 = \$3.50. When QQQQ remains stagnant or drops lower than \$44, both Jan44Calls and Jan46Calls expires worthless producing the net credit of \$0.20 as profit.

This tri-directional profit is unique to Ratio Spreads and is what makes it so powerful. The only problem occurs when the stock moves beyond the strike price of the short options. When that happens, an unlimited loss results as the short options move faster than the long options. That is why you should set up a contingent order to close some or all of those short options when the stock reaches their strike price.

Ratio Backspread are a little different as its purpose is to create unlimited profit potential out of a credit volatile options position. All other credit volatile options strategies have limited profit potential due to their nature as credit spreads but Ratio Backspread is a volatile options strategies capable of unlimited profit potential when the stock breaks out one way and a limit profit in the other way. In this sense, it is again a more advanced strategy than conventional volatile options trading strategies.

• Lowering of margin requirement when shorting near term options.
• Capable of profiting in all 3 directions.

• Lower maximum profit when putting on credit options trading positions.
• Changes maximum profit potential of call or put spreads from unlimited to limited.
• Margin is needed when shorting more options than options of the same type are bought.

•  Don't Know If This Is The Right Option Strategy For You? Try our Option Strategy Selector!

Important Disclaimer : Options involve risk and are not suitable for all investors. Data and information is provided for informational purposes only, and is not intended for trading purposes. Neither www.optiontradingpedia.com, mastersoequity.com nor any of its data or content providers shall be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon. Data is deemed accurate but is not warranted or guaranteed. optiontradinpedia.com and mastersoequity.com are not a registered broker-dealer and does not endorse or recommend the services of any brokerage company. The brokerage company you select is solely responsible for its services to you. By accessing, viewing, or using this site in any way, you agree to be bound by the above conditions and disclaimers found on this site.

Copyright Warning : All contents and information presented here in www.optiontradingpedia.com are property of www.Optiontradingpedia.com and are not to be copied, redistributed or downloaded in any ways unless in accordance with our quoting policy. We have a comprehensive system to detect plagiarism and will take legal action against any individuals, websites or companies involved. We Take Our Copyright VERY Seriously!

Site Authored by