Call Ratio Backspread Strategy: A Bullish Options Trading Approach Explained

11 February 2025
5 min read
Call Ratio Backspread Strategy: A Bullish Options Trading Approach Explained
whatsapp
facebook
twitter
linkedin
telegram
copyToClipboard

Options are derivative contracts that are not only helpful in hedging but also provide traders with a viable way to generate substantial profits. However, several traders end up booking losses while trading options. With the help of certain strategies, one can trade options while limiting the losses. The call ratio backspread is one such strategy that a trader can deploy. Let’s take a close look at it.

What is the Call Ratio Backspread Strategy?

The call ratio backspread strategy is a bullish option spread strategy that can be deployed when a trader expects the price of the underlying asset to rise significantly. Being a spread strategy, it involves buying and selling options in a particular ratio.

According to the call ratio backspread strategy, a trader buys a large number of call options and sells a lesser number of call options at a different strike price of the same expiry. Through the buying and selling of call options, the trader limits the downside while the gains could be higher if the price of the underlying asset rallies significantly.

Before we dive deeper into the strategy, let’s go over what a call option is.

A call option is a derivative contract that gives the holder the right but not the obligation to purchase a security at a given price within a specific duration. Being a derivative contract, the value of the call option increases with a rise in the price of the underlying asset and decreases with a fall in the price of the underlying asset.

By deploying the call ratio backspread strategy, the trader limits the downside while the potential gains can be unlimited. This is possible due to the ratio in which the call options are sold and bought. By selling the call options, the trader can collect the premium which can be used to purchase a larger amount of call options. The strategy limits the downside since the number of short-call options is lesser than the number of long-call options.  Typically, the strategy is executed in a ratio of 1:2, 1:3, or 2:4.

Trading the Call Ratio Backspread

The call ratio backspread is a useful bullish strategy. Let’s look at an example to learn how to trade this strategy and how the trade would fare in different scenarios.

If an asset is trading at Rs 500 and a trader expects the price of the asset to rise, the trader can make use of the call ratio backspread strategy.

Per this strategy, the trader will sell one lot of an in-the-money (ITM) call option (CE) and purchase two lots of out-of-the-money (OTM) call options. This results in a ratio of 1:2.

So, the trader will sell one lot of 490 CE (ITM) and purchase two lots of 520 CE (OTM).

The 490 CE is trading at Rs 200 – Total premium collected = Rs 200

The 520 CE is trading at Rs 80 – Total premium paid 80x2 = Rs 160.

Net cash flow = 200 – 160 = Rs 40.

Four primary scenarios may unfold.

Underlying Below the Sold Call Strike Price

In this scenario, the price of the underlying asset falls below the strike price of the sold call i.e. Rs 490. If the asset is trading at Rs 460, the trader will be able to collect the entire premium of the sold call while the bought call will expire worthless.

Net profit - 200-160 = Rs 40

Underlying Between Sold and Bought Call Strike Price

If the price of the asset rises and is between the strike prices of the sold and bought call options, the trade will be in a net loss. If the price of the asset rises to Rs 515, the 490 CE will incur a loss, while the 520 CE will expire worthless. The net loss would vary depending on how far the price of the underlying asset is from the strike prices.

490 CE – 260-200 = -60

Net loss = 160 + 60 = Rs 220

Underlying Higher than Bought Call Strike Price

If the price of the asset rises significantly, the premiums of the bought call option would swell as they are pushed to ITM. The losses of the sold call option will be offset by the gains in the bought call option due to the ratio spread.

If the asset’s price rises to Rs 540,

490 CE – 200-300 = -100

520 CE – (200-80) x 2 = 240

Net profit = 240 – 100 = Rs 140

Breakeven Scenario

The trade breaks even in two different situations. If the price of the asset is slightly higher than the sold strike price, the premium collected will offset the premium paid for the bought call. Similarly, if the asset price rises slightly higher than the bought call option’s strike price then the gains from the bought calls will offset the losses of the sold call option.

Benefits of the Call Ratio Backspread

  • The strategy limits the downside as gains from either leg can offset the losses of the other.
  • A call ratio backspread has unlimited upside potential as the bought call options can continue to expand.
  • The strategy is flexible in terms of strike prices and the ratio in which the strategy is deployed.
  • When prices are expected to rise in a volatile environment, the strategy can perform very well.

Limitations of Call Ratio Backspread

  • One of the key limitations of the strategy is that it is complex and requires a hands-on approach to manage it.
  • Theta decay can erode premiums and reduce the effectiveness of the strategy.
  • The strategy requires significant price movements to generate profits.
  • Reduced volatility can erode the value of bought call options.

Conclusion

The call ratio backspread strategy is a complex yet beneficial strategy that traders can deploy when they have a bullish outlook. The limited downside along with the potential of an unlimited upside makes this a suitable strategy for volatile markets when significant price moves are expected.

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.

To read the RA disclaimer, please click here


RA Sign -
Research Analyst - Aakash Baid
RA Date - 30th April, 2024

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. Groww Invest Tech Pvt. Ltd. (Formerly known as Nextbillion Technology Pvt. Ltd) Ltd. do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
Do you like this edition?
ⓒ 2016-2025 Groww. All rights reserved, Built with in India
MOST POPULAR ON GROWWVERSION - 5.7.5
STOCK MARKET INDICES:  S&P BSE SENSEX |  S&P BSE 100 |  NIFTY 100 |  NIFTY 50 |  NIFTY MIDCAP 100 |  NIFTY BANK |  NIFTY NEXT 50
MUTUAL FUNDS COMPANIES:  GROWWMF |  SBI |  AXIS |  HDFC |  UTI |  NIPPON INDIA |  ICICI PRUDENTIAL |  TATA |  KOTAK |  DSP |  CANARA ROBECO |  SUNDARAM |  MIRAE ASSET |  IDFC |  FRANKLIN TEMPLETON |  PPFAS |  MOTILAL OSWAL |  INVESCO |  EDELWEISS |  ADITYA BIRLA SUN LIFE |  LIC |  HSBC |  NAVI |  QUANTUM |  UNION |  ITI |  MAHINDRA MANULIFE |  360 ONE |  BOI |  TAURUS |  JM FINANCIAL |  PGIM |  SHRIRAM |  BARODA BNP PARIBAS |  QUANT |  WHITEOAK CAPITAL |  TRUST |  SAMCO |  NJ