Ratio Call Spread
The ratio call spread options strategy is established by purchasing a certain amount of calls at one strike and simultaneously selling more calls than purchased at a higher strike. It is generally a neutral options strategy. An example would be to purchase five XYZ November 95 calls and selling 10 November 100 calls. This would be a 2:1 ratio write. The spread is usually done for a credit.
As an example of this options strategy, assume XYZ is trading at 62. Further assume that the XYZ November 60 calls are 4-1/2, and the XYZ November 65 calls are 2-3/4. Selling two November 65′s and buying one November 60 would yield a credit of 1 point. The greatest downside risk is a profit of 1 point less commissions. This is because if all the calls expire worthless (XYZ closes below 65) there is still a 1 point credit left. The maximum profit occurs if XYZ is at 65 at expiration. In this case, the November 65s would expire worthless, and the November 60 call would be worth 5 points.
Maximum profit = the initial credit + difference between the two strikes (or)
Maximum profit = difference between the two strikes – the initial debit
Upside break even point = higher strike price + the points of maximum profit
An example of the upside break even point in the above ratio call spread example would be 65 + 6 = 71. Should the price of XYZ rise to 71, the position would be even.
My recommendation, and it is not shared by all options strategists or technicians, is only to enter a ratio spread for a credit. That way, even if the underlying security declines sharply in price, the ratio call spread is still profitable (don’t forget commissions). It is also a slightly bullish position; as the investor is looking for the underlying security to move up slightly in order to achieve more profit.
Follow up action, should the underlying security begin to rise in price would be to buy more calls and reduce the ratio spread to 1:1. This would turn it into a bull spread.