Introduction
The Call Ratio Spread is a smart options trading strategy that provides a balance between risk and reward in moderately bullish market conditions. It is designed for traders who expect a limited upside move in the underlying stock or index but want to reduce the cost of taking a position.
This strategy involves buying a certain number of at-the-money (ATM) or in-the-money (ITM) call options while selling a higher number of out-of-the-money (OTM) call options. The Call Ratio Spread works best when the market moves moderately upwards, without extreme volatility.
In this blog, we will explore how the Call Ratio Spread Strategy works, its risk-reward characteristics, and how to execute it efficiently using Algomojo.
What is a Call Ratio Spread?
A Call Ratio Spread is an options strategy that consists of:
✔ Buying a lower number of ATM or ITM call options (higher premium paid)
✔ Selling a higher number of OTM call options (lower premium collected)
This setup reduces the cost of the trade, sometimes even generating a small net credit, making it a cost-efficient bullish strategy.
Structure of a Call Ratio Spread
The strategy consists of two trades:
1️⃣ Buy 1 ATM or ITM Call Option (Long Leg)
2️⃣ Sell 2 OTM Call Options (Short Legs)
This creates a directional trade that benefits from moderate upward movements while having a defined risk on the downside.
Example of a Call Ratio Spread
Assume Stock XYZ is trading at ₹1000. You execute the following trades:
- Buy 1 ATM Call (Strike Price: ₹1000) at ₹50
- Sell 2 OTM Calls (Strike Price: ₹1050) at ₹25 each
📌 Net premium paid: ₹50 – (₹25 × 2) = ₹0 (Zero Cost Trade!)
📌 Possible Outcome Scenarios:
| Stock Price at Expiry | Profit/Loss | Explanation |
|---|---|---|
| ₹1000 (No Move) | Small loss | Time decay affects the long call. |
| ₹1050 (Moderate Move) | Maximum Profit | The short calls expire worthless while the long call gains value. |
| ₹1100+ (Strong Move) | Unlimited Loss | Losses increase as short calls become deep ITM. |
Key Takeaways
✅ Limited Risk – Maximum loss occurs beyond the breakeven point.
✅ Limited Profit – Best profit occurs at the sold strike price.
✅ Volatility Considerations – Works best in low-volatility environments.
✅ Cost-Efficient – Can be structured as a near-zero-cost trade.
Payoff Structure of a Call Ratio Spread
| Scenario | Impact |
|---|---|
| Price remains stagnant | ❌ Small loss due to time decay |
| Price moves up moderately | ✅ Maximum profit potential |
| Price moves up significantly | ❌ Unlimited loss (if unhedged) |
| Volatility increases | ❌ Can increase losses |
| Volatility decreases | ✅ Beneficial since short options lose value |
Advantages of a Call Ratio Spread
📈 Cost-Effective – Reduces the net premium paid or even generates a small credit.
📉 Limited Risk (Up to Breakeven) – If the stock moves slightly upward, it is a profitable trade.
⚡ Works in Low Volatility – Unlike the Call Backspread, this strategy is best suited for low volatility markets.
💰 Customizable Strategy – You can modify the ratio (e.g., 1:3 or 2:3) to fit market conditions.
Risks and Considerations
❌ Unlimited Loss Beyond Breakeven – If the stock price rises too much, the short calls create large losses.
❌ Limited Profit Potential – The best profit occurs at the short call strike, after which profits diminish.
❌ Margin Requirements – Requires higher margin compared to simple spreads due to uncovered short calls.
Step-by-Step Implementation in Algomojo
With Algomojo, traders can seamlessly execute Call Ratio Spread strategies using automated order placement and execution.
1. Create a Buy ATM/ITM Call for Long Leg (Leg 1)
📍 Path: My Strategy → New Strategy
✔ Choose a near-the-money strike price.
✔ Select the ATM or ITM call option with the correct expiration.
✔ Verify lot size and margin requirements.
2. Create a Sell 2 OTM Calls for Short Leg (Leg 2 & 3)
📍 Path: My Strategy → New Strategy
✔ Choose a higher strike price than the long call.
✔ Sell 2 OTM call options.
✔ Ensure correct lot size and margin allocation.
3. Group the Strategy
📍 Path: My Group Strategy → New Group Strategy
✔ Combine both legs into a single Call Ratio Spread.
✔ Name the strategy for easy identification.
4. Enable Paper Trade Mode
📍 Path: My Group Strategy
✔ Test the strategy before deploying it in live markets.
✔ Simulate market conditions to observe behavior.
5. Generate a BUY Signal
📍 Path: My Group Strategy
✔ Click BUY to place both orders simultaneously.
6. Executed Paper Trade Orders
📍 Path: My Group Signals → Orders
✔ Verify that both legs are successfully placed in the Order Book.
✔ Ensure all contracts are filled at the intended strike and expiration.
7. Monitor Open Positions
📍 Path: My Group Signals → Positions
✔ Track price movements and implied volatility (IV) changes.
✔ Monitor the time decay (Theta) effect.
8. Generate a SELL Signal to Exit the Trade
📍 Path: My Group Strategy
✔ Exit the position if the stock reaches the desired profit target.
✔ Close the trade before expiration to capture gains.
9. Confirm Closing Orders
📍 Path: My Group Signals → Orders
✔ Ensure both legs are exited at the intended price.
✔ Validate the final PnL impact.
10. Review Trade Performance
📍 Path: My Group Signals → Positions
✔ Analyze profit/loss metrics.
✔ Optimize future Call Ratio Spreads based on insights.
Frequently Asked Questions (FAQ)
1️⃣ How is a Call Ratio Spread different from a Call Backspread?
📌 Call Ratio Spread: Limited profit and unlimited risk on upside.
📌 Call Backspread: Unlimited profit and limited risk.
2️⃣ What happens if the stock moves sideways?
📌 A small loss occurs due to time decay.
3️⃣ Can I execute a Call Ratio Spread with ITM options?
📌 Yes, but OTM options provide higher leverage.
4️⃣ Is this strategy suitable for high volatility markets?
📌 No, Call Ratio Spreads work best in low volatility environments.
5️⃣ Can I execute this strategy manually?
📌 Yes, but Algomojo automates execution, reducing manual errors.
Final Thoughts
The Call Ratio Spread Strategy is an excellent choice for traders looking to capitalize on a moderate bullish move while keeping costs low and risk manageable.
By using Algomojo, traders can efficiently execute, monitor, and refine this strategy with automated multi-leg execution and real-time tracking.
💡 Have you tried a Call Ratio Spread before? Share your experience in the comments! 🚀🔥
Would you like a payoff chart for this strategy? Let me know! 😊