Lesson 29: Ratio Spread Strategy - Gambling on Limited Volatility with Asymmetric Positions
Author: Zhang Wuji wepoets
Ratio spreads are not a tool for making huge profits, but a precision instrument for capturing volatility. A true trading master never gambles on trends, but only weaves a net in shocks.
Core Logic: Leverage Reconstruction of Risk-Return
The essence of the ratio spread strategy is to amplify the profit potential in a specific range while controlling costs by buying and selling different numbers of option contracts.
When investors expect the price of the underlying asset to experience limited fluctuations (such as a moderate rise or narrow fluctuations) but want to avoid the risk of unilateral put options, they can build a "buy less and sell more" option portfolio to form a "bottom-line and elastic" income structure. This strategy is like "installing a spring in the investment portfolio" - it can accumulate income in fluctuations and capture excess returns from breakthroughs.
Take Bitcoin options as an example: if the current price of the currency is $62,000, investors believe that it may rebound to $65,000 after halving, but the probability of breaking through $70,000 is low. At this time, you can buy 1 call option with an exercise price of $63,000 (premium $4,500), and sell 2 call options with an exercise price of $68,000 (premium $2,200 each), with a net income of $100 (4,400-4,500).
If the currency price rises to $66,000 at maturity, the purchased option will make a profit of $3,000, and the two options sold will still be out-of-the-money, with a net profit of $3,100. If the currency price unexpectedly soars to $72,000, the purchased option will make a profit of $9,000, but the two options sold will lose $8,000 ($4,000 each), and the final net profit will be only $1,000.
This characteristic of "making money from shocks and drinking soup from breakthroughs" makes it a precise tool for a neutral market.
Construction method: Three-level balancing technique
Step 1: Matching Volatility and Term
Choose assets whose implied volatility (IV) is in the mean reversion range. For U.S. stocks, it is advisable to focus on blue-chip stocks after the earnings season, such as the consolidation phase after Apple's stock price broke through $200; the crypto market can capture the contraction of volatility after major upgrades. For example, the current price of Ethereum is $1,800. If the expected volatility within 30 days is no more than 15%, the spread can be designed around $15,000-2,500.
Step 2: Design of exercise price ratio
Options bought are usually at the same price or slightly out of the money, while options sold are set at the expected resistance level. The price spread ratio of US stocks is often set at 1:2, and assets with a volatility of over 100% such as Bitcoin can be expanded to 1:3. For example, assuming that Tesla's stock price is $220, buying one call option with an exercise price of $230 and selling three call options with an exercise price of $260 will form a "buy one and sell three" structure, which not only covers the expected increase, but also reduces the net cost through premium hedging.
Step 3: Dynamic Break-even
Net premium = total income from selling options - total expenditure from buying options.
Break-even point = short option strike price + (maximum profit/number of options sold).
Take Nvidia options in the US as an example: buy 1 call option with an exercise price of $850 (premium of $40), sell 2 call options with an exercise price of $900 (premium of $25 each), net cost -$10 (50-40). Maximum profit = 900-850-(-10) = $60, break-even point = 900+60/2 = $930. This means that the stock price needs to break through $960 before turning profit into loss, leaving sufficient buffer for unexpected market conditions.
Risk management: limited costs and flexible hedging
The maximum return of the ratio spread = exercise spread + net premium, and the theoretical risk = no upper limit (call ratio) or no lower limit (put ratio).
Dynamic stop loss: When the underlying asset breaks through the second strike price, immediately buy an equal amount of out-of-the-money options to hedge. For example, if Bitcoin suddenly soars above $70,000, you can buy additional $71,000 call options to convert the risk exposure into a butterfly combination.
Volatility hedging: Start the strategy when IV is 20% below the historical average, and close the position when IV rebounds 15% above the entry level. For example, enter the market when the S&P 500 IV hits 18%, and exit the market when it rebounds to 22%, earning volatility mean reversion benefits.
Term matching: Weekly contracts are used for short-term event-driven US stocks, while quarterly contracts for Bitcoin are more suitable for trend strategies. Before the 2024 Federal Reserve interest rate meeting, Apple's weekly ratio spread yield is 12% higher than the monthly contract because its time loss curve is steeper.
Next issue preview:
Tomorrow we will learn about the Iron Eagle Strategy
Homework
1. Actual deduction: Assuming that the current share price of Coinbase is $150, buy 1 call option with an exercise price of $160 (premium of $6), and sell 2 call options with an exercise price of $180 (premium of $3 each). Please calculate: • Net cost and break-even point • Rate of return when the share price rises to $170 • Theoretical loss when the share price exceeds $200
2. Market observation: Select Ethereum next month options on the Deribit platform, compare the break-even point differences between the 1:2 and 1:3 ratio spreads, and determine which ratio is more suitable for the current market based on the 20-day historical volatility.
