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Ratio Spread - What is a Front Ratio Put & Call?

Overview

A front ratio spread is a neutral to slightly directional strategy placed so that there is either no upside or downside risk. A Front Ratio Spread is created by purchasing a put or call debit spread with an additional short put or call at the short strike of the debit spread.

Front Ratio Put Spread

DEFINITION

A Front Ratio Put Spread is a neutral to bearish strategy that is created by purchasing a put debit spread with an additional short put at the short strike of the debit spread. The strategy is generally placed for a net credit so that there is no upside risk.

PROFIT/LOSS CHART

RATIO-PUT-SPREAD.png

DIRECTIONAL ASSUMPTION

Neutral-Bearish

IDEAL IMPLIED VOLATILITY ENVIRONMENT

High

Front Ratio Call Spread

DEFINITION

A Front Ratio Call Spread is a neutral to bullish strategy that is created by purchasing a call debit spread with an additional short call at the short strike of the debit spread. The strategy is generally placed for a net credit so that there is no downside risk.

PROFIT/LOSS CHART

RATIO-CALL-SPREAD.png

DIRECTIONAL ASSUMPTION

Neutral-Bullish

IDEAL IMPLIED VOLATILITY ENVIRONMENT

High

SETUP

Front Ratio Put Spread

Buy an ATM or OTM put option

Sell two further OTM put options at a lower strike

Front Ratio Call Spread

Buy an ATM or OTM call option

Sell two further OTM call options at a higher strike

HOW TO CALCULATE MAX PROFIT / BREAKEVEN(S)

MAX PROFIT

FRONT RATIO PUT SPREAD

Distance Between Long Strike & Short Strike + Credit Received

FRONT RATIO CALL SPREAD

Distance Between Long Strike & Short Strike + Credit Received

BREAKEVEN(S)

FRONT RATIO PUT SPREAD

Short Put Strike - Max Profit Potential

FRONT RATIO CALL SPREAD

Short Call Strike + Max Profit Potential

tastytrade approach

Our go to ratio-spread is a front-ratio spread. We normally do not route back-ratio spreads, which is where we are purchasing more options than we are selling, because this would be routed for a debit. We always prefer to collect premium and put ourselves in high probability situations. The beauty of this trade is that if we’re directionally wrong, it doesn’t matter if our spread expires OTM as long as we collect a credit - that will then be our profit. We route front-ratio spreads as a means to get into a long or short stock position with a very beneficial breakeven point. We tend to use these strategies if we have a price target in mind for the underlying. We will usually place our short strike at that target, as that would yield max profit at expiration if the stock ends up there.

CLOSE / MANAGE

WHEN TO CLOSE

When the position reaches 25% to 50% of maximum profit potential.

WHEN TO MANAGE

When the debit spread portion of the trade can be closed for near max profit, the debit spread portion can be sold while holding the additional short option. If the trader wants to extend duration on the position, the short option can be rolled to the next month.

SUPPLEMENTAL CONTENT

Episodes on Ratio Spreads

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