A strategy consisting of simultaneously buying and selling an unequal number of option contracts with different Strike prices but with the same underlying security, type (long and short call options, or long and short put options), and expiration date. When a ratio spread has more short options than long options, simply called a “ratio spread”, it has substantial or unlimited risk of losses. In a “ratio back spread”, the long side has the higher number of contracts and the risk is limited. Ratio spreads may be opened at a credit or debit, and may have a bullish, bearish, neutral, or dual nature.
Ratio spreads are traded in the Combos sub-tab of the Advanced Options tab in the Trading window.
This strategy requires the investor to purchase call options at a particular strike price and sell a greater number of higher strike calls, with the same underlying and expiration date. Thanks to the extra short calls it is often opened at a small debit to slight credit. This strategy is often used when one is slightly bullish. A bull call ratio spread delivers maximum profit when the stock trades at the higher strike price at expiration.
For use when investor anticipates:
Financial Characteristics:
Objective:
EXAMPLE (Call Ratio Spread)
Currently, XYZ trades at $23/share. The investor believes the stock will mildly appreciate and wants to participate in the upward movement but at a discount to the cost of simply buying calls. Instead, the investor employs a call ratio spread strategy of buying one in-the-money call (strike $20) for $4.00 and selling two same expiration month, out-of-the-money calls (strike $25) at $1.00 per, for a net debit of $2.00. Using this strategy, the maximum loss is unlimited if the stock price is above $25 (or, the maximum loss is $2, if the stock price is at or below $20). The investor will profit if the stock is between $22 and $28 at expiration. The maximum profit an investor can receive is the difference of the strike prices less the cost of the position, or $3 in this example.
This strategy requires the investor to purchase put options at a particular strike price and sell a greater number of lower strike puts, with the same underlying and expiration date. Thanks to the extra short puts it is often opened at a small debit to slight credit. This strategy is often used when one is slightly bearish. A bear put ratio spread delivers maximum profit when the stock trades at the lower strike price at expiration.
For use when investor anticipates:
Financial Characteristics:
* The maximum loss on a put ratio spread position remains limited as long as, and only as long as, the integrity of the spread is maintained. If the investor trades out of or exercises the long put, the maximum loss may be substantially larger.
Objective:
EXAMPLE (Put Ratio Spread)
Currently, XYZ trades at $23/share. The investor believes the stock will mildly depreciate and wants to participate in the downward movement but at a discount to the cost of simply buying puts. Instead, the investor employs a put ratio spread strategy of buying one in-the-money put (strike $25) for $3.00 and selling two same expiration month, out-of-the-money puts (strike $20) at $1.00 per, for a net debit of $1.00. Using this strategy, the maximum loss is $16.00 (or, if the stock price is at or above $25, the maximum loss is $1). The investor will profit if the stock is between $16 and $24 at expiration. The maximum profit an investor can receive is the difference of the strike prices less the cost of the position, or $4 in this example.
This strategy requires the investor to purchase call options at a particular strike price and sell a fewer number of lower strike calls, with the same underlying and expiration date. Thanks to the extra number of long contracts it is possible to make greater profits than with a traditional vertical bull spread. It is often opened at a small debit to slight credit. This strategy is often used when one is very bullish. And if the call ratio back spread is opened at a credit, in addition to potential profits in a very bullish market, a small profit may result if the market is bearish enough. A call ratio back spread delivers a theoretical maximum profit when the stock appreciates to infinity, and risk is limited. This strategy often performs most poorly in a moderately appreciating market.
For use when investor anticipates:
Financial Characteristics:
* The maximum loss on a call ratio back spread position remains as long as, and only as long as, the integrity of the spread is maintained. If the investor trades out of or exercises the low-strike call, the maximum loss may be larger or unlimited.
Objective:
EXAMPLE (Call Ratio Back Spread)
Currently, XYZ trades at $23/share. The investor believes the stock will either appreciate dramatically or depreciate and wants to profit. Limiting risk is also a goal. So the investor employs a call ratio back spread strategy of buying two out-of-the-money calls (strike $25) for $1.50 per (= $3.00), and selling one same expiration month, in-the-money call (strike $20) at $4.00 for a net credit of $1.00. Using this strategy, the maximum loss is $4.00. The investor will profit if the stock is either above $29.00 or below $21 at expiration. The maximum profit an investor can receive in this example is unlimited (XYZ at infinity) or $1 (XYZ at or below $20.00), the maximum loss is $4 (XYZ at $25.00).
This strategy requires the investor to purchase put options at a particular strike price and sell a fewer number of higher strike puts, with the same underlying and expiration date. Thanks to the extra number of long contracts it is possible to make greater profits than with a traditional vertical bear spread. It is often opened at a small debit to slight credit. This strategy is often used when one is very bearish. And if the put ratio back spread is opened at a credit, in addition to potential profits in a very bearish market, a small profit may result if the underlying security rises enough. A put ratio back spread delivers maximum profit when the stock declines to zero and risk is limited. This strategy often performs most poorly in a moderately declining market in the underlying security.
For use when investor anticipates:
Financial Characteristics:
* The maximum loss on a put ratio back spread position remains limited as long as, and only as long as, the integrity of the spread is maintained. If the investor trades out of or exercises the long put, the maximum loss may be significantly larger.
Objective:
EXAMPLE (Put Ratio Back Spread)
Currently, XYZ trades at $23/share. The investor believes the stock will either depreciate dramatically or appreciate and wants to profit. Limiting risk is also a goal. So the investor employs a put ratio back spread strategy of buying two out-of-the-money puts (strike $20) for $1.00 per (= $2.00), and selling one same expiration month, in-the-money put (strike $25) at $3.00 for a net credit of $1.00. Using this strategy, the maximum loss is $4.00 (XYZ at $20.00). The investor will profit if the stock is either below $16.00 or above $24 at expiration. The maximum profit an investor can receive in this example is $16 (XYZ at zero). If XYZ is at or above $25.00, the profit is limited to the $1.00 credit received from establishing the spread.
Commissions, taxes, and transaction costs are not included in any of these strategy discussions, but can affect final outcome and should be considered. Please contact a tax advisor to discuss the tax implications of these strategies. Many of the strategies described herein require the use of a margin account. With long options, investors may lose 100% of funds invested. In-the-money long puts need to be closed out prior to expiration, since exercising them could create short stock positions.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Multiple leg options strategies will involve multiple commissions. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options." Member SIPC
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