Call Ratio Spread Options Trading Strategy | Step-by-Step Execution Process, Payoff Graph, Pros & Cons, Adjustments

The Call Ratio Spread is a complex options strategy that involves buying a certain number of call options and selling a greater number of call options with a higher strike price. This strategy aims to profit from the difference in premium collected from the sold options and the premium paid for the bought options. It’s a neutral to slightly bullish strategy that can be used when the trader expects the underlying stock to remain stable or moderately increase in price.

Here’s an example to illustrate the Call Ratio Spread options strategy:

Let’s assume a trader is bullish on XYZ stock, which is currently trading at $100 per share. The trader believes that the stock will move up moderately in the near term, but not above $110. The trader decides to execute a Call Ratio Spread by buying two XYZ call options with a strike price of $100 and selling one XYZ call option with a strike price of $110. All options have a 30-day expiration.

The trader pays a premium of $2 for each bought call option, which equals a total cost of $4 (2 x $2). On the other hand, the trader receives a premium of $4 for the sold call option. Therefore, the net premium received is $0 ($4 – $4). The maximum profit for this strategy is unlimited, while the maximum loss is limited to the initial premium paid.

Here’s the step-by-step process of executing the Call Ratio Spread options strategy:

Step 1: Choose the underlying asset that you want to trade and perform a thorough analysis of its current market conditions.

Step 2: Select the expiration date and the strike prices for the call options.

Step 3: Buy a certain number of call options with a lower strike price and sell a greater number of call options with a higher strike price.

Step 4: Calculate the maximum profit, maximum loss, and breakeven point for the strategy.

Step 5: Monitor the trade and adjust it as necessary to manage risk and maximize profit.

Now, let’s discuss the pros and cons of the Call Ratio Spread options strategy.

Payoff Graph for Call Ratio Spread Options Trading Strategy:

Pros And Cons Of Call Ratio Spread Options Strategy:

Pros:

• The strategy allows traders to profit from a moderately bullish market outlook.
• The maximum loss is limited to the initial premium paid.
• The strategy is less expensive than buying a large number of call options outright.

Cons:

• The strategy has limited profit potential compared to buying a large number of call options outright.
• The strategy can result in a loss if the stock price moves too far above the sold call option’s strike price.

Adjustments to the Call Ratio Spread options strategy:

When in profit:

If the stock price moves up and the trader is making a profit, the trader can adjust the trade by buying back the sold call option and selling a call option with a higher strike price. This adjustment allows the trader to lock in some profit and potentially earn more profit if the stock continues to move up.

When in loss:

If the stock price moves up too far and the trader is in a loss, the trader can adjust the trade by buying back the sold call option and selling additional call options with a higher strike price. This adjustment allows the trader to reduce the loss or potentially earn a profit if the stock pulls back.

Conclusion

The Call Ratio Spread options strategy is a moderately bullish strategy that can be used to profit from a stable or moderately increasing stock price. The strategy involves buying a certain number of call options and selling a greater number of call options with a higher strike price. The maximum profit is unlimited, while the maximum loss is limited to the initial premium paid. Traders can adjust the trade as necessary to manage risk and maximize profit.