Ratio Spreads and Backspreads
Ratio Spreads and Backspreads
Ratio spreads and backspreads use unequal numbers of long and short options to create asymmetric risk/reward profiles. Unlike balanced spreads, these structures can provide unlimited profit potential in one direction or reduce cost by selling extra options. Understanding when each is appropriate helps match strategy to market outlook.
Definition and Key Concepts
Ratio Spread
A ratio spread involves buying fewer options than you sell, typically at different strikes:
- Buy 1 option at strike A
- Sell 2 options at strike B
This creates a credit or low-cost entry with limited profit in one direction but unlimited risk in the other.
Backspread
A backspread is the inverse—buy more options than you sell:
- Sell 1 option at strike A
- Buy 2 options at strike B
This often creates a debit entry but provides unlimited profit potential with limited risk.
Comparison
| Feature | Ratio Spread | Backspread |
|---|---|---|
| Long:Short ratio | 1:2 or similar | 2:1 or similar |
| Net premium | Credit or small debit | Debit |
| Unlimited risk side | Yes (extra short options) | No |
| Unlimited profit side | No | Yes (extra long options) |
| Best environment | Low volatility expected | High volatility expected |
How It Works in Practice
Call Ratio Spread Construction
Example: XYZ at $50, moderately bullish with low volatility expectation.
Trade:
- Buy 1 XYZ $50 call for $3.00
- Sell 2 XYZ $55 calls for $1.25 each ($2.50 total)
- Net debit: $0.50 ($50 per contract set)
Greeks Profile:
- Delta: +0.50 - (2 × 0.30) = -0.10 (slightly bearish at entry)
- Theta: -$0.04 + (2 × $0.03) = +$0.02 (earns time decay)
- Vega: +$0.10 - (2 × $0.08) = -$0.06 (short volatility)
Payoff Analysis:
| XYZ at Expiration | Long $50 Call | Short $55 Calls (×2) | Net P/L |
|---|---|---|---|
| $50 | $0 | $0 | -$50 |
| $55 | $500 | $0 | +$450 |
| $60 | $1,000 | -$1,000 | -$50 |
| $65 | $1,500 | -$2,000 | -$550 |
Maximum profit: $450 at $55 (the short strike) Breakeven: $55 + ($450 / 200) = $57.25 on the upside Below $50: Lose the $50 debit
Put Backspread Construction
Example: XYZ at $50, expecting a large move, biased bearish.
Trade:
- Sell 1 XYZ $50 put for $2.75
- Buy 2 XYZ $45 puts for $1.00 each ($2.00 total)
- Net credit: $0.75 ($75 per contract set)
Greeks Profile:
- Delta: +0.48 - (2 × -0.25) = -0.02 (near neutral)
- Theta: +$0.04 - (2 × $0.02) = $0 (neutral on time)
- Vega: -$0.10 + (2 × $0.06) = +$0.02 (slightly long volatility)
Payoff Analysis:
| XYZ at Expiration | Short $50 Put | Long $45 Puts (×2) | Net P/L |
|---|---|---|---|
| $55 | $0 | $0 | +$75 |
| $50 | $0 | $0 | +$75 |
| $45 | -$500 | $0 | -$425 |
| $40 | -$1,000 | $1,000 | +$75 |
| $35 | -$1,500 | $2,000 | +$575 |
Maximum loss: $425 at $45 (long strike) Breakeven: Near $45 and below ~$44 Above $50: Keep $75 credit
Worked Example
Call Ratio Spread for Range-Bound Stock
ABC trades at $100. You expect it to drift slightly higher but not explode. IV is elevated.
Trade:
- Buy 1 ABC $100 call for $5.50
- Sell 2 ABC $110 calls for $2.50 each ($5.00 total)
- Net debit: $0.50 ($50 per contract set)
Maximum Profit Zone: Maximum profit occurs at $110:
- $100 call worth $10
- $110 calls expire worthless
- Profit: $10 - $0.50 = $9.50 per share = $950
Risk Zone: Above $110, each additional $1 costs $1 (net short 1 call):
- At $115: $100 call worth $15, $110 calls worth $10 (×2 = -$10)
- Net value: $15 - $10 = $5 → P/L = $5 - $0.50 = $4.50 per share = $450
- At $120: Net value: $20 - $20 = $0 → P/L = -$50
Upper Breakeven: $110 + $9.50 = $119.50
| ABC at Expiration | Strategy Value | Net P/L |
|---|---|---|
| $95 | $0 | -$50 |
| $100 | $0 | -$50 |
| $105 | $5.00 | +$450 |
| $110 | $10.00 | +$950 |
| $115 | $5.00 | +$450 |
| $120 | $0 | -$50 |
| $125 | -$5.00 | -$550 |
This is a "tent" shaped payoff—ideal outcome at $110, loses on big moves up or if stock stays flat.
Risks, Limitations, and Tradeoffs
Naked Short Exposure in Ratio Spreads
The extra short options create unlimited risk on one side. A ratio call spread can lose infinitely on the upside; a ratio put spread can lose substantially on the downside.
Timing and Volatility Sensitivity
Ratio spreads are short vega—they lose when IV rises. Enter when IV is elevated, expecting a decline. Backspreads are long vega—they profit when IV rises.
Maximum Loss Zone
Both structures have a "zone of pain" near the short strikes where losses are maximized:
- Ratio spread: At the long strike (on the wrong side)
- Backspread: At the long strike (between sold and bought)
Assignment Risk
Extra short options in ratio spreads can be assigned. This creates stock exposure that may require management or additional capital.
Common Pitfalls
-
Ignoring unlimited risk: Ratio spreads can lose far more than the initial credit.
-
Using backspreads when volatility is already high: Long vega backspreads suffer when IV declines.
-
Misunderstanding the profit zone: Maximum profit occurs at specific price, not over a range.
-
Poor strike selection: Strikes too wide create large loss zones; too narrow limit profit.
-
Forgetting about early assignment: Deep ITM short options in ratios may be assigned.
Checklist for Ratio/Backspread Trades
- Determine directional and volatility bias
- Choose ratio spread (neutral-to-bearish vol) or backspread (bullish vol)
- Calculate net debit or credit
- Identify maximum profit price and profit zone
- Locate maximum loss zone and calculate maximum possible loss
- Find breakeven prices on both sides
- Assess current IV relative to historical average
- Size position for worst-case scenario
- Set adjustment triggers for risk management
Next Steps
Calendar spreads offer another way to trade time and volatility differentials. See Calendar Spreads for Income Generation for strategies using different expirations.
For event-driven applications of these asymmetric structures, review Event-Driven Volatility Trades.