What is a ratio call spread?

What is a ratio call spread?

Ratio call spreads are options strategies where the investor combines purchased calls and short calls at the same expiration but with different strike prices.

A Ratio Call Spread starts off as a delta-neutral strategy, which means that even if you have two long calls and one short call, the sensitivity of your overall position to move in the underlying is equal whether it moves up or down by small amounts.

Different ratios can be used for the number of options that you buy or sell, such as 2:3, 3:5, and so on, but the intention is that they all start out delta-neutral. The combined deltas of the long positions are equal to the delta of the short position because they are further out of the money, and the short position is close enough to the market price to be more dramatically affected by the price movements in that range.

When the price of the underlying begins to rise closer to the strike price of the long positions, their combined delta will increase more quickly than the short position and cause the spread to have a more positive relationship with the underlying. Delta hedging is the process of using the Black-Scholes model to mathematically hedge options alongside long stock positions to prevent any unnecessary losses.

The example above was for a long-ratio call spread, which has limited risk and unlimited profit potential. You could also buy lower-strike calls and sell twice as many higher-strike calls, but this has unlimited loss potential.