The call ratio backspread is similar in contruction to the short butterfly call spread you looked at in the previous section. The only difference is that you omit one of the components (or legs) used to build the short butterfly when constructing a call ratio backspread.
When putting on a call ratio backspread, you are neutral but want the market to move in either direction. The call ratio backspread will lose money if the market sits. The market outlook one would have in putting on this position would be for a volatile market, with greater probability that the market will rally.
To put on a call ratio backspread, you sell one of the lower strike and buy two or more of the higher strike. By selling an expensive lower strike option and buying two less expensive high strike options, you receive an initial credit for this position. The maximum loss is then equal to the high strike price minus the low strike price minus the initial net premium received.
Your potential gains are limited on the downside and unlimited on the upside.
The profit on the downside is limited to the initial net premium received when setting up the spread. The upside profit is unlimited.
An increase in implied volatility will make your spread more profitable. Increased volatility increases a long option position's value. The greater number of long options will cause this spread to become more profitable when volatility increases.
When putting on a call ratio backspread, you are neutral but want the market to move in either direction. The call ratio backspread will lose money if the market sits. The market outlook one would have in putting on this position would be for a volatile market, with greater probability that the market will rally.
To put on a call ratio backspread, you sell one of the lower strike and buy two or more of the higher strike. By selling an expensive lower strike option and buying two less expensive high strike options, you receive an initial credit for this position. The maximum loss is then equal to the high strike price minus the low strike price minus the initial net premium received.
Your potential gains are limited on the downside and unlimited on the upside.
The profit on the downside is limited to the initial net premium received when setting up the spread. The upside profit is unlimited.
An increase in implied volatility will make your spread more profitable. Increased volatility increases a long option position's value. The greater number of long options will cause this spread to become more profitable when volatility increases.
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