Ratio Vertical Spreads
Definition : An option strategy consisting of more short options than long
options having the same expiration month. Typically, the trader is short calls
(or puts) in one series of options and long a fewer number of calls (or puts)
in another series in the same expiration month on the same option class.
A ratio vertical spread, like a backspread, involves options struck at two
different prices—one long strike and one short. That means that it is a
volatility strategy that may be long or short gamma or vega depending on
where the underlying price is at the time. The ratio vertical spread is
effectively the opposite of a backspread. Let’s study a ratio vertical using
the same options as those used in the backspread example.
With the stock at $71 and one month until March expiration:
In this case, we are buying one ITM call and selling two OTM calls. The
relationship of the stock price to the strike price is not relevant to whether
this spread is considered a ratio vertical spread. Certainly, all these options
could be ITM or OTM at the time the trade is initiated. It is also not
important whether the trade is done for a debit or a credit. If the stock price,
time to expiration, volatility, or number of contracts in the ratio were
different, this could just as easily been a credit ratio vertical.
Exhibit 16.4 illustrates the payout of this strategy if both legs of the 1:2
contract are still open at expiration.