A Call Ratio Spread involves buying a number of calls at a lower strike price and selling more calls at a higher strike price of the same underlying and same expiry.
A good rule of thumb is to use a 2:1 call ratio, by selling twice the number of calls as buying.
This strategy is used when the investor is neutral to slightly bullish on the underlying security and is expecting little volatility in the short term.
How to build this strategy?
This strategy has two legs:
Leg 1 – Buy 1 ITM Call
Leg 2 – Sell 2 OTM Calls
Credit Spread/Debit Spread
This is variable.
The profit potential in this strategy is limited.
When is this strategy profitable?
The investor earns maximum profit when the price of the undelrying security at expiry is equal to the strike price of the call options sold.
The investor faces unlimited risk in this strategy.
When is this strategy unprofitable?
The investor will face large losses if the price of the underlying security rises sharply above the strike price of the call options sold.