A call ratio backspread sells one option and buys two further from the current price. It is the mirror image of the ratio spread: instead of profiting from a moderate move and losing on a large one, it loses on a moderate move and profits from a large one.
It is often presented as a low-cost way to bet on a big rally. That is accurate, with one important catch about where the loss sits. This article explains the structure, works through an example, and compares it with alternatives.
How it is built
The standard 1x2 call backspread:
Sell one call option at a strike near the current price.
Buy two call options at a higher strike, same expiry.
The one sold option, being nearer the money, brings in more premium per option than each of the two bought options costs. Depending on the strikes, the structure can be opened for a small credit, for nothing, or for a small debit.
Because two options are bought and only one is sold, there is one extra long call option. Above the higher strike, that extra option gives the position unlimited upside, in the same way the extra sold option in a ratio spread gives it unlimited downside on a large rise.
A put backspread works the same way on the downside: sell one put option near the money and buy two lower-strike put options. It profits from a large fall.
A worked example
Suppose an index is at 24,000. Illustrative prices for options with two weeks to expiry — the same as in the ratio spread article, so the two structures can be compared directly:
Sell one 24,000 call option at 170.
Buy two 24,300 call options at 60 each, paying 120.
Net credit: 170 − 120 = 50 points per unit received. Multiply by the lot size for rupees.
At expiry, below 24,000: all options expire worthless. Profit: the 50 credit.
At expiry, at 24,300: the sold option is worth 300 against you; the bought options are worth nothing. Loss: 300 − 50 = 250. This is the maximum loss.
Above 24,300, each point higher adds two points to the bought options and one point against the sold option, so the position gains one point for every point the index rises.
Breakevens: 24,050 on the lower side (where the sold option's loss equals the credit), and 24,300 + 250 = 24,550 on the upper side.
Above 24,550, the position makes money without limit. At 25,000 the profit is 450; at 25,500 it is 950.
So the position earns a small amount if the market falls or stays flat, loses most in the middle around the higher strike, and gains substantially only if the move is large.
The catch: the loss sits where moves usually end
The maximum loss occurs at the higher strike, a moderate distance above the current price. That is a zone the index reaches fairly often. Large moves through and beyond it are less frequent.
In other words, the backspread is a bet that the move will be large, not merely upward. A trader who expects a rise and uses a backspread can be right about direction and still lose the maximum, if the index rises moderately and stops near the bought strike.
Time works against the position too. With more options bought than sold, it generally loses from time decay while waiting for the move, and that decay accelerates as expiry approaches.
Volatility works for it. Because the position is net long options, a rise in implied volatility usually helps it before expiry, and a fall usually hurts. Backspreads are therefore often considered when implied volatility is relatively low and a large move is expected.
Compared with alternatives
Versus buying call options outright. A single bought call option costs premium but gains from any rise above its breakeven. The backspread can be opened for a credit, keeps that credit if the market falls, but loses more in the middle zone. It trades a defined small loss on a fall for a larger loss on a moderate rise.
Versus a long straddle. A straddle profits from a large move in either direction and costs significant premium. A call backspread profits from a large move in one direction, can cost nothing to enter, and has a loss zone only on the upside.
Versus the ratio spread. They are opposite bets. The ratio spread wants a moderate move to a target and fears a large one; the backspread fears the moderate move and wants a large one.
The choice depends entirely on your view of the size of the move, not just its direction.
Managing the position
Decide the exit before entry. Because the maximum loss sits at the bought strike, write down what you will do if the index approaches that level well before expiry — close, adjust, or hold for a breakout.
Watch time. Backspreads usually work best with enough time for a large move. Holding into the final days with the index near the bought strike is the worst combination.
Count the costs. Three options, each with charges and spreads on entry and exit.
Margin. The sold option is covered by one of the bought options, so margin is generally lower than for a naked short option, but check the requirement before placing it, and enter all legs together as a basket.
An account with basket orders and payoff views
See the payoff and margin of a multi-leg position before placing it. Free to open
Prices in the example are illustrative, not market data. Lot sizes, margin rules and charges are set by the exchanges and SEBI and change from time to time. This is educational material, not advice, and no position is recommended. We run no tips group and no signal service, we manage nobody's money, and no return is promised. Derivatives can lose more than the amount blocked against them.
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Frequently Asked Questions
What is a call ratio backspread?
An options structure that sells one call option near the money and buys two call options at a higher strike in the same expiry. It profits from a large rise, keeps a small credit on a fall, and loses most on a moderate rise.
Where is the maximum loss in a call backspread?
At the higher strike at expiry, where the sold option has lost the most and the bought options are worth nothing.
How do I calculate the breakevens?
With a net credit, the lower breakeven is the sold strike plus the credit, and the upper breakeven is the bought strike plus the maximum loss, where maximum loss is the distance between strikes minus the credit.
What is the difference between a ratio spread and a backspread?
A ratio spread sells more options than it buys and wants a moderate move. A backspread buys more than it sells and wants a large move. They are opposite bets on the size of the move.
When is a backspread typically used?
When a trader expects a large move in one direction, often when implied volatility is relatively low, and accepts a loss zone if the move turns out to be only moderate.
Related Reading
- A plan that defines every exit
- The ratio spread it mirrors
- Betting on a large move either way
- Judging whether volatility is low
- Settlement of each leg at expiry
- Theta and vega in a net-long position
Disclaimer: TheFinBaba provides educational content only - this is not investment advice. Trading involves risk of loss.
