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Ratio Call Spread Option Strategy

Ratio Call Spread Option Strategy

What is Ratio Call Spread Option Strategy?

  • Ratio Call Spread Option Strategy is Neutral to moderately bullish Strategy. In this we expect stock to remain below upper breakeven point. Ratio Call Spread is a blend of bull call spread and a Naked call sell, where naked call will be the same as higher strike of bull call spread.

When to Execute?

  • Ratio Call Spread should be implemented when expect slow rally up to the sold strike price and expecting decline in volatility.

What is the Trade?

  • In ratio call spread we generally buy one lot of At-the-money Call and sell two lots of Out-of-money Call option. The variation to ratio call spread is to use different ratios such as 1X3,2X3 or 3X5.

Breakeven for Ratio Call Spread

  • As Net Credit = Higher Strike Price + Difference in strike + Net Premium Received. As net Debit = there will be two breaks even. Upper Breakeven = Higher Strike Price – Difference in strike + Net Premium paid. Lower Breakeven = Lower Strike + Net premium Paid.

What will be maximum profit?

  • Maximum profit would occur at a higher strike price at expiry. Here the two short calls will expire worthless and long calls will turn In-the-money (ITM). It can be calculated as follows = Higher Strike – Lower Strike + net premium received.

What will be maximum loss?

  • Maximum loss is undefined above the higher breakeven because this is not a complete hedge strategy as we short on more calls than buying.

What are the advantages?

  • Net credit received acts as a cushion for any downside movement in stock. Profitable when stock remains range bound between two strikes as it has higher theta gain.

What are the disadvantages?

  • Uncapped risk if stock rises above higher BEP. Managing the trade if stock rises too fast too early. Comparatively complicated trade for intermediate traders.

Example for Ratio Call Spread:

  • Nifty future price is 15500. A Ratio Call Spread can be devised by adding one lot of 15500 Call At-the-Money (ATM) @110 and selling two of 15600 CE (ITM) @ 65. Net Premium Paid or Received = Rs. (+20). Maximum Loss undefined above 15720. Maximum profit is at 15600.