Ratio Call Spread Options Profit & Loss Calculations: Options, Futures, Derivatives & Commodity Trading

Ratio Call Spread Options Profit & Loss Calculations

Details about Profit & Loss Calculations for Ratio Call Spread Options Trading
Continuing further from our previous post Ratio Call Spread Options Trading Explained: Example & Payoff Charts , lets see the details about Profit & Loss Calculations for Ratio Call Spread.
Call Ratio Spread Payoff Function
What are the breakeven points for the Ratio Call Spread Options Trading?
Break even points are the points or spots when there is no profit - no loss for the option trader. i.e. they are the points either side of which there is a profit area and a loss area.
As can be seen from the payoff function, the Ratio Call Spread has 2 break even points, one on the upper side and one on the lower side - where the final BROWN colored graph crosses the horizontal axis (x-axis) at
Downward Breakeven Point for Ratio Call Spread Options = [Lower strike - (net debit amount/number of long contracts)]
In the above case, it will be = $45 + ($4/1) = $45 + $4 = $49

Upward Breakeven Point for Ratio Call Spread Options = [Lower strike price] + [difference between strikes * number of short contracts] / [number of short contracts - number of long contracts] + [net credit received] or - [net debit paid]

In the above case, it will be = $45 + [($55-$45)*2]/[2-1] - $4 = $45 + $20 -$4 = $61
As seen from the final BROWN colored payoff function chart, they are indicated in the final payoff function as the brown color graph crosses the horizontal axis or x-axis.

What is the maximum profit for Ratio Call Spread Options Trading?
The profit region of Ratio Call Spread is pyramid shaped.
The maximum profit occurs in the when the underlying stock price remains mid way between the upper strike price and the lower strike price.

Maximum Profit of Ratio Call Spread Options = Strike Price of Short Call - Strike Price of Long Call - Net Options Premium Paid - Brokerage & Commissions Paid
= $10 - $4 = $6 - Brokerage & Commissions Paid

What is the maximum loss for Ratio Call Spread Options Trading
The loss on the downward side is limited. It is capped to -$4 on the downward side as seen from the horizontal part of the BROWN payoff function.
However, on the upward side, the loss potential is UNLIMITED.
As the underlying strike price keep moving, the loss will continue to increase - 24, 29, 34, 39 and so on...

What are the risks in trading Ratio Call Spread Options Trading?
Trading Ratio Call Spread Options is pretty risky. You are usually paying (net debit) for a very limited profit based on the requirement that the underlying stock price will not move much.
Any big move in the stock price will directly mean loss to you - limited on the downside, but unlimited on the upside.
Any increase in volatility will mean a loss to the options trader, as increase in volatility will lead to increase in option premiums.

- The trader will need to keep a watch for both the option prices as well as the underlying stock price movements

- You need to take atleast 3 option positions at the entry and close all 3 at the exit. That will mean high cost of brokerage which may eat into your profits.

- The option trader needs to have a neutral to bearish outlook for trading Ratio Call Spread

- Time decay is beneficial to the trader as there are net short positions (in majority) as compared to long positions. But traders will take a hit for increase in volatility.

- This being a net seller (short) position, its advisable to trade this with shorter time to expiry, so that the benefit from Time Decay is maximum. See (Options Time Decay: Explained with Examples)

Let's continue further to the Greeks for Ratio Call Spread Option: Delta, Gamma, Rho, Vega, Theta
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