Ratio Spread

Core Thesis

A 1x2 Call Ratio Spread sells extra upside convexity to fund bullish exposure. It can offer low or zero entry cost, but introduces significant or unlimited upside tail risk beyond the upper break-even.

Structure

• Long 1 call at lower strike $K_1$.
• Short 2 calls at higher strike $K_2$.
• Net entry may be credit $C$ or debit.

Expiration Payoff Mathematics

For net credit $C$:

• If $S_T \le K_1$: $\Pi_T = C$.
• If $K_1 < S_T \le K_2$: $\Pi_T = (S_T-K_1)+C$.
• If $S_T > K_2$: $\Pi_T = -S_T + 2K_2 - K_1 + C$.

Implications:

• Max profit at $S_T = K_2$: $(K_2-K_1)+C$.
• Upper break-even: $2K_2 - K_1 + C$.
• Loss becomes unbounded above upper break-even.

Greek Profile

• Positive delta initially, can flip negative as spot rises through short strikes.
• Gamma turns adverse in strong upside acceleration.
• Often positive theta at entry, but path dependency is high.

Design Rules

• Best for mildly bullish / range-up views, not breakout regimes.
• Set $K_2$ near expected terminal zone, not far above without rationale.
• Keep size small due to nonlinear tail behavior.

Management Framework

• Define hard risk triggers before entry for upside breach scenarios.
• Convert to broken-wing/defined-risk structures if spot threatens upper zone.
• Avoid earnings or jump-risk windows unless explicitly hedged.

Failure Modes

• Obsessing over "free trade" credit and ignoring right-tail catastrophe.
• Inadequate liquidity to adjust when spot gaps through shorts.
• Running large notional in momentum names.

Practical Checklist

• Is your base case for spot below short strike into expiry?
• Is upper break-even far enough above plausible gap scenarios?
• Is there a preplanned conversion if upside momentum accelerates?