What is a Call Ratio Backspread?

The call ratio backspread is an investment strategy that involves selling a call at one strike price at a lower rate and then purchasing two calls at a higher strike price. This approach provides the call ratio backspread with a built in hedge component that is very likely to result in breaking even for the investor, and possible even realizing a small profit.

Because the basic process for the call ratio backspread requires coupling a sale of one call at a low strike price while buying two new calls at higher strike prices, the investor incurs very little risk. In the event that the market conditions tend to not move in the anticipated direction, the worst case scenario for the investor is likely to be realizing no profit from the venture. However, the call ratio backspread also makes it probable that the trade will not result in a loss under any circumstances. Thus, the investor essentially has nothing to lose from utilizing the call ratio backspread, but does stand the chance to make a modest profit from the venture.

The underlying point of the call ratio backspread has to do with the spread of the calls involved in the transactions. Ideally, the investor will take steps to keep the ratio of the calls sold to calls purchased under an amount of 0.67. This will set the stage for the creation of a credit regardless of which direction the underlying security moves, and is very likely to keep the transaction profitable.

Utilizing a call ratio backspread is an example of a relatively safe investment opportunity. While the potential for making a large profit is not present, the lack of a pronounced degree of risk makes the strategy very attractive to investors who prefer to play it safe and grow their portfolios incrementally. Brokers can usually assist investors in identifying underlying securities that show promise of working well with a call ratio backspread.