Ratio Backspread
A ratio backspread was a multi-leg options strategy in which a trader sold fewer options near the money and bought a greater number of options further out-of-the-money, often structured to receive a net credit at entry while retaining unlimited or large directional profit potential beyond the long strike.
The ratio backspread was categorised as a net-long vega, net-long gamma strategy despite often being entered at a net credit. The classic structure involved selling one at-the-money or near-the-money call and simultaneously buying two or more out-of-the-money calls in the same expiry. The premium received from the short call partially or fully offset the cost of the additional long calls, sometimes resulting in zero cost or a small net credit.
The profit and loss profile of a call ratio backspread was distinctive: the strategy experienced its maximum loss at the long strike at expiry, where the short call was deeply in the money while the long calls sat exactly at the money and had no intrinsic value. Below the short call strike, all legs expired worthless and the net credit, if any, was retained as profit. Above the long call strike, the two long calls gained faster than the single short call lost, producing unlimited upside potential.
In Indian F&O markets, traders historically used ratio backspreads on Nifty and Bank Nifty in situations where they anticipated a sharp directional move but were uncertain of timing. Entry at a net credit meant that if the index remained range-bound and the position expired without reaching the danger zone between strikes, no loss was incurred. The downside was the limited but defined loss if the index settled precisely at the long strike.
Put ratio backspreads followed the same logic in reverse: selling a near-the-money put and buying two further out-of-the-money puts, targeting large downside moves. These were particularly examined during periods of elevated downside risk, such as in February 2020 during the early pandemic sell-off, when aggressive put-side backspreads could be structured cheaply due to the volatility skew.
The strategy required careful strike selection because the maximum loss zone was a specific price range rather than a binary outcome. Risk managers noted that ratio backspreads, despite their potential credit entry, carried significant intermediate risk and were most suitable for participants with a clear directional conviction and an understanding of the underlying volatility surface.