The Call Ratio Backspread is used by options traders who speculate on a strong increase of the underlying. In the process Call options with different strike prices are bought and sold in different quantities. Depending on the choice of strike prices, a relatively small loss or a small profit is generated when prices fall. However, for a significant profit to occur, a strong price movement is necessary.
Definition Call Ratio Backspread
A call ratio backspread is an option strategy that consists of a sold Call option (Short Call) and a larger number of call options purchased (Long Call) with higher strike price and same remaining term exists
The call ratio backspread is therefore the counterpart of a ratio call spread. An only moderate increase of the underlying leads to a loss at expiration. However, in case of a strong price movement, the trade has an unlimited profit potential, similar to a long call.
Ratio spreads are usually set up with a ratio of 2:1 or 3:1. However, other ratios can also be traded, such as 4:1, 3:2, 5:2, etc.
P&L diagram of a call ratio backspread
In the profit and loss diagram, you can see that when the underlying is bullish, the trade must first cross a Verlsutzone before a profit can be made. If prices fall, a relatively small profit or loss is generated.
What should I pay attention to when trading a call ratio backspread?
A call ratio backspread corresponds to a Bear Call Spread with an additional long call (or several). There are no fixed rules for the selection of the strike prices. Often a strike price close to the current price is chosen for the short call (At The Money) and a higher strike price is chosen for the long calls (Out Of The Money).
Depending on the choice of strike prices, a credit or a debit is created when the trade is opened. In order to make a profit in a bullish price development, the call ratio backspread must first cross a loss zone.
Maximum loss
The maximum loss occurs when the long calls expire worthless and the short call produces the largest possible loss. This price level is located at the strike price of the long calls.
Maximum loss = strike price long call - strike price short call + net debit
Or:
Maximum loss = strike price long call - strike price short call - net credit
Maximum and realized profit
In order to achieve a profit with a call ratio backspread in the event of a bullish development of the underlying, it must first cross the loss zone. If the price rises above the level of the long calls, the additional long call compensates for the loss of the bear call spread and the trade generates a profit after crossing the break-even point. The further the price rises, the higher the profit. Thus, the maximum profit cannot be calculated.
Break Even Point
The break-even point can be calculated by taking the maximum possible loss added to the price level of the long calls will.
Break Even Point = strike price long call + maximum loss