Ratio Spread
Quick Definition
An options strategy that involves buying and selling unequal numbers of options at different strikes, creating an asymmetric risk/reward profile.
What Is Ratio Spread?
A ratio spread involves buying a certain number of options at one strike and selling a larger number at a different strike, with the same expiration. Common ratios include 1:2 (buy one, sell two) or 1:3. For example, a 1:2 call ratio spread involves buying one lower-strike call and selling two higher-strike calls. The extra short option creates additional premium income, often allowing the spread to be entered for a credit or small debit. However, the extra short option is "naked" (uncovered), creating unlimited risk in one direction. The strategy profits when the underlying stays near the short strike at expiration. Ratio spreads are used by experienced traders who have a strong directional view with a specific target price. Back-ratio spreads (buying more than selling) reverse this profile, providing unlimited profit potential in one direction.
Ratio Spread Example
- 1Buy 1x $100 call for $5, sell 2x $110 calls for $2.50 each — entered at zero cost. Max profit at $110 ($10), but unlimited risk above $120 from the extra naked call
- 2A 1:3 put ratio spread: buy 1x $50 put, sell 3x $45 puts. Profits if the stock drops to $45, but suffers accelerating losses below $40 from the two extra short puts
Related Terms
Vertical Spread
An options strategy involving buying and selling options of the same type and expiration but at different strike prices.
Butterfly Spread
A neutral options strategy combining a bull spread and bear spread with three strike prices, profiting most when the underlying stays near the middle strike.
Naked Option
An option sold without holding the underlying asset or an offsetting position, exposing the seller to theoretically unlimited risk.
Call Option
A contract giving the holder the right, but not the obligation, to buy an underlying asset at a specified price within a specified time period.
Put Option
A contract giving the holder the right, but not the obligation, to sell an underlying asset at a specified price within a specified time period.
Strike Price
The predetermined price at which the holder of an option can buy (call) or sell (put) the underlying asset upon exercise.
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