1x2 Call Ratio Spread: Breakevens and Naked Risk

A ratio spread dey buy one option and sell more than one against am, usually two, for a further strike with the same expiration. The extra short contract dey pay for most of the position and cap the profit at the short strike. E still leave one call with nothing above am, and na for there the arithmetic stop to be friendly.

Wetín 1x2 call ratio spread really hold

The standard version na 1x2 call ratio: buy one call for lower strike, sell two calls for higher strike, with the same underlying and expiration date. Break am into parts: one long call plus one short call na ordinary vertical, the structure wey credit spreads and debit spreads cover. The second short call no get long option above am. That leg na naked, meaning obligation to deliver 100 shares for the short strike, no matter how far the stock move.

The ratio spread arithmetic: two breakevens and one peak

Round numbers make the algebra clear, so make we use hypothetical stock wey dey $100. Buy the $100 call for $6.00 and sell two $110 calls for $2.50 each. Net cost na $6.00 minus $5.00, meaning debit of $1.00 per share, or $100 for the package.

At expiration, the position dey operate for four regions:

• Under $100, every call expire worthless and the loss na the $1.00 debit.
• Between $100 and $110, the long call dey in the money and the two shorts no dey. Position gain one dollar per share for every dollar wey stock rise, and turn positive at $101.00. Na this be the lower breakeven.
• For $110, the long call worth $10.00 and both shorts expire worthless. Peak value na $10.00 minus the $1.00 debit, or $900 per contract.
• Above $110, the long call gain one dollar while the two shorts lose two. Position lose one dollar per share as price rise, and give back the full $9.00 at $119.00. Na this be the upper breakeven.

For general form, make A be the long strike, B the short strike and C the net cost per share. C dey negative when the package enter as credit. Maximum profit na (B - A) - C, and e happen for B. Upper breakeven na maximum profit add to B, wey give 2B - A - C. Debit version still get lower breakeven for A + C. Credit version no get lower breakeven, because every call expire worthless under A and the credit remain banked.

After the upper breakeven, loss dey grow dollar for dollar with the stock, with no cap. A 1x3 ratio lose two dollars per share for every dollar wey stock rise. No strike arrangement fit remove that leg.

Run the payoff with your own numbers

The structure get four numbers: two strikes, two premiums and the ratio. Below na base image python3 heredoc, standard library only. You no need install or fetch anything. E go print net cost, peak, both breakevens and the expiration payoff across a price grid, beside the plain 1x1 vertical for comparison.

python3 - <<'PY'
# 1x2 call ratio: buy 1 call at the lower strike, sell RATIO calls at the higher one.
SPOT = 100.00
LONG_STRIKE,  LONG_PREMIUM  = 100.00, 6.00
SHORT_STRIKE, SHORT_PREMIUM = 110.00, 2.50
RATIO = 2                      # short contracts per long contract

net_cost   = LONG_PREMIUM - RATIO * SHORT_PREMIUM      # per share, negative is a credit
max_profit = (SHORT_STRIKE - LONG_STRIKE) - net_cost   # per share, reached at the short strike
upper_be   = SHORT_STRIKE + max_profit / (RATIO - 1)   # slope above the short strike is 1 - RATIO
lower_be   = LONG_STRIKE + net_cost

def ratio_payoff(px):
    return (max(px - LONG_STRIKE, 0)
            - RATIO * max(px - SHORT_STRIKE, 0)
            - net_cost)

def vertical_payoff(px):
    return (max(px - LONG_STRIKE, 0)
            - max(px - SHORT_STRIKE, 0)
            - (LONG_PREMIUM - SHORT_PREMIUM))

print("net %s of %.2f per share" % ("debit" if net_cost > 0 else "credit", abs(net_cost)))
print("max profit %.2f per share, at %.2f" % (max_profit, SHORT_STRIKE))
if net_cost > 0:
    print("lower breakeven %.2f" % lower_be)
else:
    print("lower breakeven none, the credit is kept under %.2f" % LONG_STRIKE)
print("upper breakeven %.2f, then unbounded" % upper_be)
print()
print("%8s %10s %10s" % ("price", "1x2", "1x1"))
for step in range(17):
    px = SPOT * (0.90 + 0.025 * step)
    print("%8.2f %10.2f %10.2f" % (px, ratio_payoff(px), vertical_payoff(px)))
PY

With the strikes and premiums from the example above, e print:

net debit of 1.00 per share
max profit 9.00 per share, at 110.00
lower breakeven 101.00
upper breakeven 119.00, then unbounded

   price        1x2        1x1
   90.00      -1.00      -3.50
   92.50      -1.00      -3.50
   95.00      -1.00      -3.50
   97.50      -1.00      -3.50
  100.00      -1.00      -3.50
  102.50       1.50      -1.00
  105.00       4.00       1.50
  107.50       6.50       4.00
  110.00       9.00       6.50
  112.50       6.50       6.50
  115.00       4.00       6.50
  117.50       1.50       6.50
  120.00      -1.00       6.50
  122.50      -3.50       6.50
  125.00      -6.00       6.50
  127.50      -8.50       6.50
  130.00     -11.00       6.50

Read the two columns compare them. Both remain flat under the long strike: ratio dey down $1.00, while vertical dey down $3.50. Ratio climb reach $9.00 for $110 and give the gain back as price rise, crossing zero between $117.50 and $120.00. This one surround the $119.00 upper breakeven wey the grid print above. Vertical cap for $6.50 above the short strike and stop moving there permanently. Multiply either column by 100 to get the per-contract figure. Set RATIO to 3 and the fall after the peak go steepen to two dollars per share for every dollar. Raise SHORT_PREMIUM until net_cost turn negative, and the lower breakeven go disappear.

Margin dey come from the naked leg, no be strike width

Vertical spread get worst case wey the distance between strikes determine, and the margin wey broker hold follow that number. Ratio spread no get fixed worst case. The covered half cancel out, while the remaining short call dey margined as uncovered call. The formula start with percentage of the underlying full value, adjust for how far out of the money the strike dey, then add the premium collected. Distance between the strikes no enter the calculation. Narrow ratio and wide ratio on the same stock fit carry similar requirement for the naked leg, and that requirement dey move with share price during the session. margin for selling naked options get the full mechanics.

How often stock don cover that distance?

Upper breakeven na a distance with deadline attached. Here be how that distance compare with wetin AAPL actually travel over matching window: every 25-session stretch, about five calendar weeks, from January 2021 through July 2026, grouped by where the stock finish.

WITH
    daily AS
    (
        SELECT
            date,
            toFloat64(max(close)) AS close_px
        FROM global_markets.stocks_daily_aggs
        WHERE ticker = 'AAPL'
          AND date >= '2021-01-04'
          AND date <= '2026-07-31'
        GROUP BY date
    ),
    indexed AS
    (
        SELECT
            date,
            close_px,
            row_number() OVER (ORDER BY date) AS n
        FROM daily
    ),
    moves AS
    (
        SELECT 100 * (b.close_px / a.close_px - 1) AS fwd_move_pct
        FROM indexed AS a
        INNER JOIN indexed AS b ON b.n = a.n + 25
    ),
    totals AS
    (
        SELECT count() AS all_windows FROM moves
    )
SELECT
    multiIf(
        fwd_move_pct < -5,  'down more than 5%',
        fwd_move_pct <  0,  'down 0 to 5%',
        fwd_move_pct <  5,  'up 0 to 5%',
        fwd_move_pct < 10,  'up 5 to 10%',
        fwd_move_pct < 15,  'up 10 to 15%',
                            'up more than 15%')  AS move_bucket,
    count()                                       AS window_count,
    round(100 * count() / any(t.all_windows), 1)  AS share_of_windows_pct
FROM moves AS m
CROSS JOIN totals AS t
GROUP BY move_bucket
ORDER BY min(m.fwd_move_pct)

Windows wey finish up more than 15% make up 5.8% of the sample, 80 of dem. Ratio wey upper breakeven sit inside one of the crowded middle buckets don get overtaken often before. One wey dey beyond the far bucket don get overtaken rarely. Both counts describe history for one name over one stretch only, and none of dem talk about the next five weeks.

Assignment on the short strikes

Listed US equity options na American style: person fit assign a short call on any business day, no be only at expiration. If both short calls get assigned at once, e deliver 200 shares short per 1x2. The long call still cover 100 of dem, leaving 100-share short position beside a long call. Margin go carry the position until trader unwind am. Early assignment on calls dey cluster before ex-dividend dates, when the time value remaining in a deep in-the-money call drop below the dividend wey exercising holder go collect. Ex-dividend dates and options explain this comparison, while when short options get assigned early cover the other cases.

Why the last week dey awkward

The peak na one point, no be plateau. Gamma, the rate at which option delta dey change, concentrate around the strike as expiration dey near. The position directional exposure dey flip fastest exactly where payoff highest. If stock stay near the short strike into the final session, trader go dey guess how many of the two shorts go come back assigned. Traders commonly close the position or roll am to later expiration before that week. That one reset the peak and both breakevens at a new cost.

FAQ

Wetín be 1x2 ratio spread?

1x2 ratio spread dey buy one option and sell two for a further strike with the same expiration. For call version, long call cover one short call, while the second one remain uncovered. That uncovered leg determine the risk profile.

Ratio spread get two breakevens?

Call ratio wey open for net debit get two. Lower one na long strike plus the debit. Upper one na short strike plus maximum profit. Version wey open for credit get only upper breakeven, because the credit remain for any price under the long strike.

Why ratio spread need naked option margin?

Uncovered short call carry obligation wey no get cap. Standard margin formula start from percentage of underlying value, no be the distance between strikes. The amount wey broker hold dey change as share price move.

Wetín happen if short calls get assigned early?

Assignment on both shorts deliver 200 shares short per 1x2, and the long call cover 100 of dem. Wetin remain na short stock position beside long call until trader close am. Assignment on calls dey happen most often just before ex-dividend date.

Ratio spread na the same thing as backspread?

Dem be mirror images. Ratio spread sell more contracts than e buy and carry the open-ended side as risk. Backspread buy more than e sell, use a nearer short to fund the extra long contracts, and carry the open-ended side as profit.

The panel above come with the SQL wey produce am, and the script go take any strikes and premiums wey you give am. Run the same arithmetic on any chain for the Strasmore terminal.