What Is a Ratio Spread?
A ratio spread involves buying and selling different quantities of options at different strike prices. The most common is the 1x2 ratio call spread: buy 1 lower-strike call and sell 2 higher-strike calls. This creates a position that profits in a range but has unlimited risk beyond the upper breakeven. Ratio spreads can be constructed for zero cost or even a credit.
Ratio spreads are advanced strategies used by experienced traders to express a view on both direction and magnitude. The extra short option(s) generate additional premium but create naked exposure above (calls) or below (puts) the breakeven. This makes them riskier than standard vertical spreads but potentially more profitable in the target zone.
Unlike standard vertical spreads, ratio spreads have undefined risk on the side with extra short options. A 1x2 ratio call spread has unlimited upside risk because there is one naked short call. Always understand your risk before trading ratio spreads.
Ratio Spread Formulas
- 1Net = (2 × $2.25) - $4.00 = $0.50 credit
- 2Max profit at $105: ($105-$100) + $0.50 = $5.50 per share ($550)
- 3Upper breakeven = $105 + $5.50 = $110.50
- 4Below $100: keep $0.50 credit ($50 per position)
- 5Above $110.50: losing $1 per $1 stock move (1 naked call)
- 6Risk is unlimited above $110.50
| Stock | Long Call | Short Calls (2x) | Net P&L |
|---|---|---|---|
| $95 | $0 | $0 | +$50 (credit) |
| $100 | $0 | $0 | +$50 |
| $105 | $500 | -$0 | +$550 (max) |
| $108 | $800 | -$600 | +$250 |
| $110.50 | $1,050 | -$1,100 | $0 (BE) |
| $115 | $1,500 | -$2,000 | -$450 |
Using Ratio Spreads
- 1x2 ratio is most common; 2x3 and 1x3 are also used
- Can be entered for a credit, making the downside risk-free
- Naked short options require margin and create unlimited risk
- Popular among experienced traders for specific price targeting
- Can be converted to a butterfly by adding a long wing
If you want unlimited profit potential with defined risk, consider a ratio backspread (buy 2, sell 1 instead of buy 1, sell 2). Backspreads profit from large moves and have defined risk, but they often cost more to enter.