Ratio spread — Options Strategy

A ratio spread involves buying one option and selling two or more options at a different strike, creating an asymmetric position where additional premium is collected in exchange for taking on naked (undefined) risk beyond the sold strikes. The most common is a 1:2 ratio—buy one ATM option, sell two OTM options—creating a position that has a sweet spot profit zone at the short strikes and unlimited risk beyond them.

Ratio spreads are typically entered for a credit (or zero cost) by ensuring the two sold options generate enough premium to pay for the single bought option. This means you get into the trade for free while establishing a position that profits from moderate movement toward the short strikes. The catch is the uncovered leg—the second short option has no hedge against a large move.

Call ratio spreads (1 long call, 2 short calls) make the most of a mildly bullish scenario: the stock needs to rise to the short call strikes for maximum profit but must not rally dramatically beyond those strikes to avoid the uncovered short call risk. Put ratio spreads (1 long put, 2 short puts) benefit from moderate bearish moves to the short put strikes.

Ratio spreads are advanced strategies best suited for traders who have experience managing undefined risk. The uncovered portion requires monitoring and management—if the stock makes an explosive move past the short strikes, losses can be significant. Many traders use ratio spreads only when they are confident the stock will not make a dramatic move in the ratio leg's direction.

In high-IV environments, ratio spreads can be entered for a significant credit, creating a 'free' trade structure where even a full reversal to zero on the long leg still leaves you profitable from the credit received. This financing feature makes them popular among premium-selling traders looking for higher returns on low-volatility scenarios.