A ratio spread is an advanced options strategy where you buy and sell options in unequal quantities. This creates an asymmetric payoff that can be very profitable if you are right about direction and magnitude. This guide explains how ratio spreads work and when to use them.
What is a Ratio Spread?
A ratio spread involves buying options at one strike and selling more options at a different strike. The most common ratio is 1:2 (buy one, sell two). Because you sell more than you buy, you can often enter for a credit or small debit.
Key concept: You are selling extra options to finance your trade. If the stock moves to your short strike and stops, you make maximum profit. If it moves too far past your short strike, the extra shorts can hurt you.
Types of Ratio Spreads
Call Ratio Spread (Bullish)
Buy one lower strike call, sell two higher strike calls. Profits if the stock rises to the short strike by expiration.
Put Ratio Spread (Bearish)
Buy one higher strike put, sell two lower strike puts. Profits if the stock falls to the short strike by expiration.
Example: Call Ratio Spread
Stock ABC is at $100. You expect it to rise to around $110 but not much higher.
- Buy 1 x $100 call for $5.00 (pay $500)
- Sell 2 x $110 calls for $2.50 each (receive $500)
- Net cost: $0 (entered for even)
At expiration:
- Stock at $100: All options expire worthless. Result: $0
- Stock at $110: Long call worth $10 ($1,000). Short calls expire worthless. Profit: $1,000
- Stock at $120: Long call worth $20 ($2,000). Short calls worth $10 each ($2,000 loss). Net: $0
- Stock at $130: Long call worth $30 ($3,000). Short calls worth $20 each ($4,000 loss). Net: -$1,000
The Payoff Profile
A ratio spread has a unique payoff shape:
- Below the long strike: Small loss or breakeven (depends on initial cost)
- Between strikes: Profit increases as stock moves toward short strike
- At short strike: Maximum profit
- Above short strike: Profit decreases and eventually turns to loss
The sweet spot is when the stock lands exactly at your short strike at expiration. This is where you make maximum profit.
Why Use Ratio Spreads?
- Low or zero cost entry: Selling extra options finances the trade
- High profit potential: Maximum profit can be several times your risk
- Target a specific price: Perfect when you have a price target in mind
- Time decay neutral to positive: The extra short options decay in your favor
The Risks
The main risk is the stock moving too far past your short strike:
- Call ratio spread: Unlimited risk to the upside (extra naked call)
- Put ratio spread: Substantial risk to the downside (stock can go to zero)
Warning: Standard ratio spreads have undefined risk in one direction. The extra short option is essentially naked. This requires higher margin and approval levels. Only use ratio spreads if you understand and can manage this risk.
Managing Ratio Spread Risk
- Set stop losses: Close the trade if the stock moves past a certain point
- Add a wing: Buy a further out option to cap your risk (makes it a broken wing butterfly)
- Choose realistic targets: Do not expect the stock to land perfectly on your strike
- Size appropriately: Keep position size small relative to your account
Call Ratio Spread Setup
- Select a stock with moderate bullish outlook
- Buy 1 ATM or slightly OTM call
- Sell 2 calls at your price target
- Aim for zero cost or small credit entry
- Set a stop loss above the short strike
Put Ratio Spread Setup
- Select a stock with moderate bearish outlook
- Buy 1 ATM or slightly OTM put
- Sell 2 puts at your downside target
- Aim for zero cost or small credit entry
- Set a stop loss below the short strike
Example: Put Ratio Spread
Stock XYZ is at $100. You expect it to fall to around $90 but not crash.
- Buy 1 x $100 put for $5.00 (pay $500)
- Sell 2 x $90 puts for $2.50 each (receive $500)
- Net cost: $0
At expiration:
- Stock at $100: All options worthless. Result: $0
- Stock at $90: Long put worth $10 ($1,000). Short puts worthless. Profit: $1,000
- Stock at $80: Long put worth $20 ($2,000). Short puts worth $10 each ($2,000). Net: $0
- Stock at $70: Long put worth $30 ($3,000). Short puts worth $20 each ($4,000). Net: -$1,000
Ratio Spread vs Regular Spread
| Ratio Spread | Regular Spread | |
|---|---|---|
| Options ratio | 1:2 or other | 1:1 |
| Entry cost | Low or credit | Debit or credit |
| Risk | Can be unlimited | Defined |
| Best for | Specific price target | Directional bet |
When to Avoid Ratio Spreads
- High volatility stocks that can make big moves
- Earnings or other binary events
- When you are unsure about your price target
- If you cannot afford the margin requirement
Analyze Your Complex Spreads
Pro Trader Dashboard shows the profit and loss profile of your ratio spreads. See your breakeven points, max profit zone, and risk at a glance.
Summary
A ratio spread is when you buy options at one strike and sell more options at another strike. This creates a low-cost trade with high profit potential if the stock moves to your target. However, standard ratio spreads have unlimited risk in one direction because of the extra short option. Use ratio spreads when you have a specific price target and can manage the risk of being wrong.
Want to learn more? Check out back spreads for the opposite strategy or butterfly spreads for defined-risk targeting.