Trading Options in Turbulent Markets: Master Uncertainty through Active Volatility Management

Chapter 17. Ratio Spreading: Trading Objectives Tailor Made

When working with options contract spreads, think of the spread as an asset. Treat the spread, however you build it, however many options contracts you buy or sell, and however you design the strategy, as a position in itself, as if it were two thousand shares of stock or twenty call contracts. Your spread will be more than the net income or cost to set up the position, more than the average strike price between the contracts you buy and the contracts you sell, and more than the likely volatility. This is especially true with a back spread or a ratio spread, as this investment strategy tends to be a lot more complex than a vertical spread or a calendar spread. For a back spread or ratio spread you might be tempted to add layers of complexity, mull over your opportunities, and tinker with expiration dates, strike prices, and quantities in order to control for greek values and implied volatilities. The problem with this approach is that no matter how sophisticated your strategy, your spread will tend take on a life of its own. The spread will behave as unpredictably as any other investment in a complicated marketplace, and the more complex you make a spread, the more this unpredictability applies.

How Back Spreads and Ratio Spreads Work

With a back spread or ratio spread, you are buying and selling complementary options contracts, as with a vertical spread, where the expiration date is the same but the strike prices differ, ...