Ratio Backspreads is a Credit volatile options trading strategy that opens up one leg for unlimited profit through selling a smaller amount of in the money options against the purchase of at the money or out of the money options of the same type.
As the same suggests, Ratio Backspreads are backspreads, which means that they are options trading strategies designed to profit no matter if a stock goes upwards or downwards strongly. Such volatile conditions might be expected ahead of important news releases, court rulings, rate decisions and any conditions that might cause uncertainty as to the future direction of the market or stock. Ratio Backspreads allow options traders to take both bullish and bearish stance simultaneously in order to profit no matter which way the underlying stock moves.
Ratio Backspreads vs Regular Backspreads
First of all, Ratio Backspreads are exactly like the regular back spreads in the sense that both are designed to profit when the underlying stock goes up or down strongly. The difference between Ratio Backspreads is that ratio backspreads has the advantage of being the only credit backspreads that are capable of unlimited options trading profit in a single direction! No regular credit backspreads are capable of unlimited profits either way. The Short Butterfly Spread has limited profit no matter if the stock goes up or down but the Call Ratio Backspread has unlimited profit if the stock went upwards and a limited profit if the stock went downwards. This is the main difference between Ratio Backspreads and regular credit backspreads. In fact, ratio backspreads are backspreads with a directional bias. This directional bias is what sets ratio backspreads apart from the regular backspreads. Ratio backspreads are truly examples of the extreme flexibility and versatility that you can only get through options trading.
Use of Ratio Backspreads
You should use Ratio Backspreads when you are of the opinion that a stock might breakout strongly to topside or downside and that there is a higher chance it will break out in a certain direction and continue in that direction. For instance, if you are of the opinion that XYZ would stage a breakout soon and the breakout would probably be to upside. You want to have unlimited profit to ride the upside profits should that happen but you also want to make a limited profit if XYZ should break out to downside instead. In this case, you would use a Call Ratio Backspread.