We have been bombarded with questions about ratio spreads in class. Let’s start out with explaining a Call Ratio Spread, though that is not the favored strategy.
A Ratio Spread is a combination of a larger quantity of short deep OTM options, and long OTM options at a different strike price. The premium taken in for selling a larger quantity of short, deep OTM options occasionally is greater than the premium paid for the long OTM options, thus creating a credit. But, typically an option trader of ratio spreads ends up with a small debit. Multi-legged options have contract fees for each and every single leg, which can add up and eat away into any potential return. The goal is to select a broker that does not charge an outdated ticket fee on top of existing fees per option contract. Option traders should look for the most economical way to trade when it comes to brokerage fees, commissions, and ticket charges.
Let us look in detail at a possible ratio spread: a call ratio spread. This particular advanced option strategy is known at different brokerage houses by different names; for instance Ratio Vertical Spread with Calls, or Call Front Spread. Regardless of the different labels for the name, the spread is built with calls that are disproportionate in quantity and in the same expiration. Namely, there are more short calls at the higher strike than long calls at the lower strike. If it was the other way around, then we have… Continue Reading
