What is a Ratio Spread?

A ratio spread involves buying one option and selling multiple options at a different strike. The ratio creates a position that profits from moderate moves but has unlimited risk in one direction.

For example, a 1:2 ratio spread buys one call and sells two calls at a higher strike. If the stock rises moderately, you profit. If it rises too much, you face unlimited losses.

How Ratio Spread Works

Let me show you with Reliance example. Suppose Reliance is at ₹2,800:

  1. Buy 1 Reliance 2,800 Call at ₹50
  2. Sell 2 Reliance 2,900 Calls at ₹25 each (total ₹50)
  3. Net cost: ₹0 (zero cost)

If Reliance closes at ₹2,900, your profit is ₹100 per share (from the bought call). If it goes above ₹3,000, you start losing on the two sold calls.

Ratio Put Spread

A ratio put spread buys one put and sells multiple puts at a lower strike. This profits from moderate declines but has unlimited risk if the stock falls too much. Use this when you are moderately bearish but do not expect a crash.

Risk Management

Ratio spreads have undefined risk in one direction. Always use stop losses or convert to a broken wing butterfly to limit risk. Professional traders use ratio spreads only when they have strong conviction about the direction.

SEBI Disclaimer

This article is for educational purposes only. Options trading involves substantial risk of loss.

The 1:2 and 1:3 Mechanics

A ratio spread sells more far-dated options than it buys, funding the long leg with a double-strength short leg. The two classics:

  • 1:2 ratio call spread: buy one 25000 call, sell two 25600 calls; near-zero cost, and it profits if the underlying drifts to the short strike, then decays.
  • 1:3 variant: the credit grows and the maximum loss window narrows, but the short-C position beyond the sold strike becomes a three-lot naked exposure when triggered.

The trade is not direction-agnostic: it profits from a preferred zone and must be sized as a defined move bet, not as a covered position.

Margin and Assignment Risk

Ratio spreads convert into open short exposure at the point the market runs through your sold strikes. The consequences:

  • Margin jumps when the naked side activates; a 1:3 spread beyond the sold strike holds three lots of naked short premium, whose margin is several times the collected credit.
  • Early assignment on the short calls near dividend diaries or deep ITM converts your ratio into an instant cash position with a financing cost attached.
  • Never let the activated ratio run unmanaged past the day it touches; the defined risk philosophy ends where the ratio's tail begins.

Turning Into a Short Straddle

Sometimes the market hands you a rescue: at expiry, if the short strikes are both untested, the ratio spreads literally collapses into a short straddle with credit already banked. That's not a bug, it's the ratio's payoff anatomy. The disciplined treatment:

  • Convert consciously when the short legs are both OTM and the remaining time-to-decay justifies holding the straddle as a new, consciously sized short-vol position.
  • Or deconstruct instead: close the extra long or the excess shorts depending on where price sits relative to the short strikes.

The ratio's "free straddle" only pays if the market cooperates; treat the conversion as a separate decision with its own stop, not as free money in motion.

Exit Triggers That Protect the Premium

Premium decay is the ratio's friend only while the price behaves. Standard triggers:

  • Take profits when the whole spread's value drops 50-60% of the credit, reflecting successful decay entry.
  • Abort the ratio when the underlying trades through the sold strike by more than 0.75%: the naked tail thesis is finished.
  • Exit the position on any two consecutive days of the underlying making unfavourable highs or lows; stubbornness here is how the credit evaporates.

A Nifty Worked Example in Round Numbers

Nifty at 25000, IV modest, 21 days to expiry:

  • Buy 1 Nifty 25000 call at 220, sell 2 Nifty 25500 calls at 120 each: net credit 20 points.
  • Max gain if Nifty settles at 25500: the 500 points you gain on the long minus 240 paid, plus the 200 total short credit arrived early, roughly 280 points per spread.
  • If Nifty explodes to 26000: the 25600-26000 short calls each lose 400 points, and with two shorts the loss is 800 points minus the 500 long gain.

Sizing the ratio in lots rather than intuition is mandatory; the leverage that makes the payoff attractive is the same leverage that makes the tail expensive.