Ratio Spreads and Back Spreads

Every strategy you have met so far has used its legs in equal numbers: one bought call against one sold call, one put against one put. A ratio spread deliberately breaks that balance. You buy one option and sell two, or sell one and buy two, so the legs no longer cancel cleanly. That imbalance can create a position that costs almost nothing to put on, yet it hides a sharp edge: somewhere on the chart there is an option you sold that nothing protects. This chapter walks the call ratio spread and its mirror, the call ratio back spread, on real RELIANCE numbers, and shows you exactly where the extra risk lives so it never surprises you.

What makes a spread a ratio

A normal vertical spread pairs one long option with one short option at a different strike. The numbers of contracts match, so your risk is boxed in on both sides. A ratio spread uses an unequal count, most commonly one against two. That single extra contract changes everything about the shape.

Think about why. When you sell two 1360 calls but own only one 1320 call, the first short call is covered by your long call, the two of them forming an ordinary bull call spread. The second short call has nothing behind it. It is a naked call, and a naked call carries unlimited risk because a share price has no ceiling. So a ratio spread is really a defined-risk spread bolted onto one extra naked leg, and the naked leg decides the whole character of the trade.

We build everything on the same RELIANCE anchor used across this course: spot Rs 1,318, at-the-money strike 1320, lot 500, expiry 28 July 2026. The modelled premiums we need are the 1320 call at about Rs 31 a share (Rs 15,590 a lot) and the 1360 call at about Rs 16 a share (Rs 7,795 a lot).

The call ratio spread

The classic call ratio spread is mildly bullish but expects the rise to stall. Here are the legs.

Notice the money. You pay Rs 15,590 for the single long call and collect about Rs 15,590 from the two short calls, so the position goes on for roughly zero net cost. That is the seductive part: a trade that is close to free to enter. The catch is buried on the right side of the chart.

Walk the solid expiry line from left to right.

• Below 1320, every call expires worthless. You paid almost nothing to enter, so you finish near flat, neither winning nor losing much beyond the small net premium.
• From 1320 up to 1360, your long 1320 call gains intrinsic value while both 1360 calls are still worthless. The position climbs steadily and reaches its peak profit of Rs 20,000 exactly at 1360, where the long call is worth 40 points on 500 shares and the short calls have expired with no value.
• Above 1360, the picture turns. Your covered pair (long 1320, one short 1360) is now maxed out, but the second, naked 1360 call starts losing rupee for rupee. Profit shrinks from the Rs 20,000 peak, crosses back through zero, and beyond that point you are in a loss that grows without limit the higher RELIANCE travels.

So the call ratio spread pays best when RELIANCE drifts up to land right around 1360, and it punishes you precisely when the stock does what bulls dream of, a runaway rally.

Reading the three numbers

A ratio spread does not have one tidy breakeven and one max loss the way a vertical spread does, so read its shape rather than memorising a single figure.

The dotted cyan line on the chart is the value today, before expiry. Today the position is gentler and rounder than the sharp expiry tent, because the naked call still holds time value that has not yet decayed. As 28 July approaches, the dotted curve collapses onto the solid line, the peak at 1360 sharpens, and the unlimited right tail steepens. Time decay actually helps this position while price sits below the short strike, because the two calls you sold lose value faster than the one you own. That tailwind is real, but it never cancels the naked-leg danger above.

The call ratio back spread

Flip every leg and you get the call ratio back spread, the mirror image. Now you sell the cheaper structure and buy the extra contract, so the naked risk disappears and is replaced by unlimited reward instead.

Again the money roughly washes out, so you enter for close to nothing. But the payoff is upside down compared with the ratio spread.

Walk the solid line again.

• Below 1320, all calls expire worthless and you finish near flat.
• Around 1360, you hit your worst point, a loss of about Rs 20,000. Here your single short 1320 call is deep enough to hurt while your two long 1360 calls have only just reached the money and carry no intrinsic value yet.
• As RELIANCE pushes higher, the two long calls take over. Past 1400 the position turns up, and because you own two calls against one short, every further rupee adds Rs 500 twice over against Rs 500 once. The profit climbs without limit on a big up move.

So the back spread is the trade for someone who expects a powerful rally and wants unlimited upside with a known, capped loss if they are wrong. Its maximum loss is about Rs 20,000, and it is paid only if RELIANCE stalls right at 1360.

Where the risk hides, and credit versus debit

The lesson that outlives the specific strikes is this: count your legs before you read the chart. Any time the bought and sold contracts do not match, ask one question first, which side has the extra, unmatched option, and is it bought or sold.

• An extra sold option is a naked leg. It hands you premium today and an unlimited tail tomorrow. That is the call ratio spread.
• An extra bought option costs you a little and gives you the unlimited tail in your favour. That is the back spread.

You can also tune these structures by sliding the strikes, which turns them into credit or debit versions. Move the short strikes closer or widen the gap and the net premium shifts from a small payment you make to a small credit you receive. A credit feels nice, but it never removes the naked-leg risk in a ratio spread; it only changes the small amount that changes hands at the start. The shape of the right tail is set by the leg count, not by the credit.

Ratio spreads are where beginners first meet a position that looks almost free yet can lose far more than it ever pays. The honest takeaway is simple. The call ratio spread offers a Rs 20,000 peak at 1360 and an unlimited loss above, so it belongs to traders who can manage a naked call and will not be tempted by the costless entry. The back spread flips that, capping your loss near Rs 20,000 and leaving the upside open. Next we look at how two options can copy a future outright, and how selling a call against stock you own turns a holding into a small income machine.