## 4.1 – Background

The Call Ratio Back Spread is an interesting options strategy. I call this interesting keeping in mind the simplicity of implementation and the kind of pay off it offers the trader. This should certainly have a spot in your strategy arsenal. The strategy is deployed when one is out rightly bullish on a stock (or index), unlike the bull call spread or bull put spread where one is moderately bullish.

At a broad level this is what you will experience when you implement the Call Ratio Back Spread-

- Unlimited profit if the market goes up
- Limited profit if market goes down
- A predefined loss if the market stay within a range

In simpler words you can get to make money as long as the market moves in either direction.

Usually, the Call Ratio Back Spread is deployed for a ‘net credit’, meaning money flows into your account as soon as you execute Call Ratio Back Spread. The ‘net credit’ is what you make if the market goes down, as opposed to your expectation (i.e market going up). On the other hand if the market indeed goes up, then you stand to make an unlimited profit. I suppose this should also explain why the call ratio spread is better than buying a plain vanilla call option.

So let’s go ahead and figure out how this works.

## 4.2 – Strategy Notes

The Call Ratio Back Spread is a 3 leg option strategy as it involves **buying two OTM** call option and **selling one ITM** Call option. This is the classic 2:1 combo. In fact the call ratio back spread has to be executed in the 2:1 ratio meaning 2 options bought for every one option sold, or 4 options bought for every 2 option sold, so on and so forth.

Let take an example – assume Nifty Spot is at 7743 and you expect Nifty to hit 8100 by the end of expiry. This is clearly a bullish outlook on the market. To implement the Call Ratio Back Spread –

- Sell
**one**lot of 7600 CE (ITM) - Buy
**two**lots of 7800 CE (OTM)

Make sure –

- The Call options belong to the same expiry
- Belongs to the same underlying
- The ratio is maintained

The trade set up looks like this –

- 7600 CE, one lot short, the premium received for this is Rs.201/-
- 7800 CE, two lots long, the premium paid is Rs.78/- per lot, so Rs.156/- for 2 lots
- Net Cash flow is = Premium Received – Premium Paid i.e 201 – 156 =
**45**(Net Credit)

With these trades, the call ratio back spread is executed. Let us check what would happen to the overall cash flow of the strategies at different levels of expiry.

Do note we need to evaluate the strategy payoff at various levels of expiry as the strategy payoff is quite versatile.

**Scenario 1 – Market expires at 7400 (below the lower strike price)**

We know the intrinsic value of a call option (upon expiry) is –

Max [Spot – Strike, 0]

The 7600 would have an intrinsic value of

Max [7400 – 7600, 0]

= 0

Since we have sold this option, we get to retain the premium received i.e Rs.201

The intrinsic value of 7800 call option would also be zero; hence we lose the total premium paid i.e Rs.78 per lot or Rs.156 for two lots.

Net cash flow would Premium Received – Premium paid

= 201 – 156

= **45**

**Scenario 2 – Market expires at 7600 (at the lower strike price)**

The intrinsic value of both the call options i.e 7600 and 7800 would be zero, hence both of them expire worthless.

We get to retain the premium received i.e Rs.201 towards the 7600 CE however we lose Rs.156 on the 7800 CE resulting in a net payoff of **Rs.45.**

**Scenario 3 – Market expires at 7645 (at the lower strike price plus net credit)**

You must be wondering why I picked the 7645 level, well this is to showcase the fact that the strategy break even is at this level.

The intrinsic value of 7600 CE would be –

Max [Spot – Strike, 0]

= [7645 – 7600, 0]

= 45

Since, we have sold this option for 201 the net pay off from the option would be

201 – 45

= 156

On the other hand we have bought two 7800 CE by paying a premium of 156. Clearly the 7800 CE would expire worthless hence, we lose the entire premium.

Net payoff would be –

156 – 156

= **0**

So at 7645 the strategy neither makes money or loses any money for the trader, hence 7645 is treated as a breakeven point for this trade.

**Scenario 4 – Market expires at 7700 (half way between the lower and higher strike price)**

The 7600 CE would have an intrinsic value of 100, and the 7800 would have no intrinsic value.

On the 7600 CE we get to retain 101, as we would lose 100 from the premium received of 201 i.e 201 – 100 = 101.

We lose the entire premium of Rs.156 on the 7800 CE, hence the total payoff from the strategy would be

= 101 – 156

= **– 55 **

**Scenario 5 – Market expires at 7800 (at the higher strike price)**

This is an interesting market expiry level, think about it –

- At 7800 the 7600 CE would have an intrinsic value of 200, and hence we have to let go of the entire premium received i.e 201
- At 7800, the 7800 CE would expire worthless hence we lose the entire premium paid for the 7800 CE i.e Rs.78 per lot, since we have 2 of these we lose Rs.156

So this is like a ‘double whammy’ point for the strategy!

The net pay off for the strategy is –

Premium Received for 7600 CE – Intrinsic value of 7600 CE – Premium Paid for 7800 CE

= 201 – 200 – 156

= **-155**

This also happens to be the maximum loss of this strategy.

**Scenario 6 – Market expires at 7955 (higher strike i.e 7800 + Max loss)**

I’ve deliberately selected this strike to showcase the fact that at 7955 the strategy breakeven!

But we dealt with a breakeven earlier, you may ask?

Well, this strategy has two breakeven points – one on the lower side (7645) and another one on the upper side i.e 7955.

At 7955 the net payoff from the strategy is –

Premium Received for 7600 CE – Intrinsic value of 7600 CE + (2* Intrinsic value of 7800 CE) – Premium Paid for 7800 CE

= 201 – 355 + (2*155) – 156

= 201 – 355 + 310 – 156

=** 0**

**Scenario 7 – Market expires at 8100 (higher than the higher strike price, your expected target)**

The 7600 CE will have an intrinsic value of 500, and the 7800 CE will have an intrinsic value of 300.

The net payoff would be –

Premium Received for 7600 CE – Intrinsic value of 7600 CE + (2* Intrinsic value of 7800 CE) – Premium Paid for 7800 CE

= 201 – 500 + (2*300) – 156

= 201 – 500 + 600 -156

= **145**

Here are various other levels of expiry, and the eventual payoff from the strategy. Do note, as the market goes up, so does the profits, but when the market goes down, you still make some money, although limited.

## 4.3 – Strategy Generalization

Going by the above discussed scenarios we can make few generalizations –

- Spread = Higher Strike – Lower Strike
- Net Credit = Premium Received for lower strike – 2*Premium of higher strike
- Max Loss = Spread – Net Credit
- Max Loss occurs at = Higher Strike
- The payoff when market goes down = Net Credit
- Lower Breakeven = Lower Strike + Net Credit
- Upper Breakeven = Higher Strike + Max Loss

Here is a graph that highlights all these important points –

Notice how the payoff remains flat even when the market goes down, the maximum loss at 7800, and the way the payoff takes off beyond 7955.

## 4.4 – Welcome back the Greeks

I suppose you are familiar with these graphs by now. The following graphs show the profitability of the strategy considering the time to expiry and therefore these graphs help the trader select the right strikes.

Before understanding the graphs above, note the following –

- Nifty spot is assumed to be at 8000
- Start of the series is defined as anytime during the first 15 days of the series
- End of the series is defined as anytime during the last 15 days of the series
- The Call Ratio Back Spread is optimized and the spread is created with 300 points difference

The thought here is that the market will move up by about 6.25% i.e from 8000 to 8500. So considering the move and the time to expiry, the graphs above suggest –

**Graph 1 (top left) and Graph 2 (top right)**– You are at the start of the expiry series and you expect the move over the next 5 days (and 15 days in case of Graph 2), then a Call Ratio Spread with 7800 CE (ITM) and 8100 CE (OTM) is the**most profitable**wherein you would sell 7800 CE and buy 2 8100 CE. Do note – even though you would be right on the direction of movement, selecting other far OTM strikes call options tend to lose money**Graph 3 (bottom left) and Graph 4 (bottom right)**– You are at the start of the expiry series and you expect the move in**25 days**(and expiry day in case of Graph 3), then a Call Ratio Spread with 7800 CE (ITM) and 8100 CE (OTM) is the most profitable wherein you would sell 7800 CE and buy 2 8100 CE.

You must be wondering that the selection of strikes is same irrespective of time to expiry. Well yes, in fact this is the point – Call ratio back spread works best when you sell slightly ITM option and buy slightly OTM option **when there is ample time to expiry**. In fact all other combinations lose money, especially the ones with far OTM options and especially when you expect the target to be achieved closer to the expiry.

Here are another bunch of charts; the only difference is that the move (i.e 6.25%) occurs during the 2^{nd} half of the series –

**Graph 1 (top left) & Graph 2 (top right)**– If you expect the move during the 2^{nd}half of the series, and you expect the move to happen within**a day (or within 5 days, graph 2)**then the best strikes to opt are deep ITM and slightly ITM i.e 7600 (lower strike short) and 7900 (higher strike long). Do note, this is not the classic combo of an ITM + OTM spread, instead this is an ITM and ITM spread! In fact all other combinations don’t work.**Graph 3 (bottom right) & Graph 4 (bottom left)**– If you expect the move during the 2^{nd}half of the series, and you expect the move to happen within**10 days (or on expiry day, graph 4)**then the best strikes to opt are deep ITM and slightly ITM i.e 7600 (lower strike short) and 7900 (higher strike long). This is similar to what graph 1 and graph 2 suggest.

Again, the point to note here is besides getting the direction right, the strike selection is the key to the profitability of this strategy. One needs to be diligent enough to map the time to expiry to the right strike to make sure that the strategy works in your favor.

What about the effect of volatility on this strategy? Well, volatility plays a key role here, have a look at the image below –

There are three colored lines depicting the change of “net premium” aka the strategy payoff versus change in volatility. These lines help us understand the effect of increase in volatility on the strategy keeping time to expiry in perspective.

**Blue Line**– This line suggests that an increase in volatility when there is ample time to expiry (30 days) is beneficial for the Call ratio back spread. As we can see the strategy payoff increases from -67 to +43 when the volatility increase from 15% to 30%. Clearly this means that when there is ample time to expiry, besides being right on the direction of stock/index you also need to have a view on volatility. For this reason, even though I’m bullish on the stock, I would be a bit hesitant to deploy this strategy at the start of the series if the volatility is on the higher side (say more than double of the usual volatility reading)**Green line**– This line suggests that an increase in volatility when there are about 15 days time to expiry is beneficial, although not as much as in the previous case. As we can see the strategy payoff increases from -77 to -47 when the volatility increase from 15% to 30%.**Red line –**This is an interesting, counter intuitive outcome. When there are very few days to expiry, increase in volatility has a negative impact on the strategy! Think about it, increase in volatility when there are few days to expiry enhances the possibility of the option to expiry OTM, hence the premium decreases. So, if you are bullish on a stock / index with few days to expiry, and you also expect the volatility to increase during this period then thread cautiously.

### Key takeaways from this chapter

- The Call Ratio Backspread is best executed when your outlook on the stock/index is bullish
- The strategy requires you to sell 1 ITM CE and buy 2 OTM CE, and this is to be executed in the same ratio i.e for every 1 sold option, 2 options have to be purchased
- The strategy is usually executed for a ‘net Credit’
- The strategy makes limited money if the stock price goes down, and unlimited profit if the stock price goes up. The loss is pre defined
- There are two break even points – lower breakeven and upper breakeven points
- Spread = Higher Strike – Lower Strike
- Net Credit = Premium Received for lower strike – 2*Premium of higher strike
- Max Loss = Spread – Net Credit
- Max Loss occurs at = Higher Strike
- The payoff when market goes down = Net Credit
- Lower Breakeven = Lower Strike + Net Credit
- Upper Breakeven = Higher Strike + Max Loss
- Irrespective of the time to expiry opt for slightly ITM + Slightly OTM combination of strikes
- Increase in volatility is good for this strategy when there is more time to expiry, but when there is less time to expiry, increase in volatility is not really good for this strategy.

Download Call Ratio Back Spread Excel Sheet

Thanks sir for this wonderful strategy . I am having two points here to ask.

1) Can we select the strike prices such that the spread and net credit are more or less same. So that the max. loss will be minimum. (Spread-net credit)? Is it practically possible to select premiums like that?

2) the pay off you have mentioned is adjusted against the time decay. It is more of concern when time to expiry is more.

Once again the topic is covered in a very simple way and easy to understand and grasp. .

Spread and Credit cannot be same. Net Credit is always lesser than the spread.

Time decay is not a good thing for this strategy, the only way it would works is when markets go higher.

What shall be practical minimum value for Max loss (spread- credit) so that it becomes worth taking position?

This depends on your risk appetite 🙂

1. Sir can you send payoff excel so that pay off calculation will be easy. [email protected] is id.

2. Does it gives profit intraday if upper and lower strike is crossed in intraday or time value also matters?

Thanks

Pawan

The excel can be downloaded at the end of the chapter, the link is provided.

You may experience an profit intraday, although holding this to expiry makes more sense.

Can we buy put instead of selling call?? I personally modified this strategy this way at zerodha and it worked well for me in volatile market. The beauty and versatality of option strategy is that you can always improvise…dont we??

Of course you can always improvise. Options are like white canvas, your imagination is the only limiting factor for what you can create on it.

Hi sir can I use this strategy for election result which is on may23 .

If the situation demands, then maybe you should 🙂

OK, I was asking that the charts shown here and in P/L calculation for month end etc, whether time decay is considered or not? If not then our P/L will be different.

Oh ok…time decay is considered since the chart depicts the payoff at expiry.

Hey karthik!!

Thank you very much to you and zerodha for varsity content!! Best on internet I must say!!

I can’t understand what graphs are conveying? i.e., target hits in 5, 10, 15, 25 and last day of expiry. Ofcourse they are showing the profits percentage but why they are above and below the x-axis. I’m totally confused. Please let me out of this confusion.

Thanks, Harsh.

Target hits in 5, 10, 15, 25 —- > these are the number of days in which the profit is supposed to hit.

Sir, How much margin for selling an itm option overnight.. Also is it possible to do this intra day.. I mean every day in a month.. We don’t keep risk of overnight news shocks and also margin requirements? Please enlighten

The margins will be similar to futures margin. Check our margin calculator here – https://zerodha.com/margin-calculator/SPAN/

There is no directional risk here for this strategy as either ways you make some money…the problem will be if the stock stays where it is. Also, this strategy is not really suitable for intraday.

Hey Karthik,

i just had a small doubt regarding the profitability graphs. There is a line that says “The following graphs show the profitability of the strategy:. So the graph for 7800 strike means- a call ratio back spread with a short 7800 strike Call and 2 long 8100 Calls? Just a little confused here

Absolutely!

Hi kartik

As I learn in option theory chapter, that today is Dec, then Dec. Is current month, Jan. Is mid month and Feb. Is far month. But in nifty we see good volumes in March, April,… Contracts. Is it possible to buy March, April,… Contracts when current month is Dec. ????

Can you please post a screen shot?

Why nifty has trade in April contract

These are quarterly contracts, here is an extract from NSE –

The Exchange shall introduce long term option contracts on NIFTY. The options cycle shall be as under.

The 3 serial month contracts would continue to exist.

The following 3 quarterly months of the cycle March / June / September / December would be available.

After these, 5 following semi-annual months of the cycle June / December would be available, so that at any point in time there would be options contracts with atleast 3 year tenure available

Thanks

That means if I have 6 month view on nifty I can buy quarterly contact and for 3 months we follow as above

Yes.

Sir please check the pic attached and suggest whether we can invest in this case or not. As per my calculations it was showing always profit… Is it true??

There is no strategy that will always give you a profit 🙂

My guess is you have forgotten to multiply the 520 CE by 2…remember you have to buy 2 call option for every 1 sold option!

I have chosen 2 sell -3 buy strategy instead of 1 sell -2 call.

It should be in the same ratio – 2 sell 4 buy.

In this article itself it is mentioned as “4.2 – Strategy Notes

In fact the call ratio back spread has to be executed in the 2:1 ratio meaning 2 options bought for every one option sold, or 3 options bought for every 2 option sold, so on and so forth.” And if this is typo error, whats wrong if we have strategy in 3:2.

My bad, will make the necessary changes.

Karthik I think you forget to calculate IV for 2 call option in your excel sheet for G23 to G29 cell correct me if I am wrong!!!

Will check and get back soon!

Sir

What happens if i implement the strategy at the starting of month and square off say after 10days. Will my P&L will be same as per payoff graph?

The payoff is only upon expiry…if you happen to close the position earlier your P&L will be slightly different.

Hi kartik

Can you please tell me what will be the value of nifty upon expiary in January

I wish I knew this myself 🙂

What if option expires otm ,then sensex exercise charges will washout all gain.

There is nothing like exercise charges.

I think he was alluding to the high STT that is charged when long options get exercised. However, it’s only done for ITM long Options not OTM long Options…

You may want to check this – https://tradingqna.com/t/no-more-stt-trap-on-exercised-in-the-money-options/18977

sir,good,what if we close the sold option (bcoz of margin pressure)&leave long calls&try.enlighten

In that case the existing long position would be ‘naked’, which will come with its usual set of risk and reward characteristics.

i am saying if option expires as ITM,then sensex STT/tax service charges are too high which will wash out all gain.

Not really. It really depends on how much ITM it is. For example if you have 7500CE and market expires at 7510, then yes your profits get washed off with these charges…but if the market is at 7520 or 7525 then you still take home quite a bit.

could not get this.

7510, 7520 why should make such a difference. In both cases it is ITM ?

Assume you paid a premium of Rs.10 of 7500 CE. If the market exprires at 7510 then you will not make any money as the 10 points you make goes towards adjusting for STT and related charges. However if its 7520, then you have 10 points remaining after adjusting for transnational expenses.

Long Strangle is not better than this strategy coz it gives profit in both direction?

Long strangle also gives profit in both direction. It shall have very good movement in any direction then it is profitable.

Well, long strangle/straddle are both direction independent. Whereas this one is biased towards a bullish outcome.

sir,i think all these selling option stategies works well with stock option rather index clarify.whare can we look historical charts of nifty&commodities(10years)

My experience says it works well on both indices and stocks.

Hi ,

first of all thanks for this great article..Can you please send the excel of Put Ratio Back Spread please..Humble request.

Thankfully

Zerodha Client

Ankit, will include this when the chapter is ready.

Thanks in advance looking forward for the same eagerly..

Hopefully soon 🙂

sir.where can we look historical charts of commodities nifty etc of last 10 years

Kite & Pi.

Dear Karthik, Thanks a lot for the chapter humble request for you to please make an excel of put ratio back spread as soon as you can..Sorry for being pushy but really require it at this time of the session and the fall as the protection trade…Thanks a lot email is [email protected] ..God bless

Will try my best Ankit, but it looks little tight!

Hello Dear KARTHIK,YOU ARE DOING A GREAT JOB KEEP IT UP, YES PUT RATIO BACK WILL BE HELPFUL.

Very soon, please stay tuned 🙂

sir.

,thanks,smalldoubt,where can we look histirical price data in NSE SITE (option prices of last 1 month) sorry for silly question clarify

Check this Narsimha – http://www.nseindia.com/products/content/derivatives/equities/historical_fo.htm

sir,thanks.we are desperate to hear about BACK TESTING&EXPERT ADVISOR whan can we expect that module

Soon. Meanwhile please go through this – http://zerodha.com/z-connect/tradezerodha/pi-tradezerodha/eas-for-auto-buysell-signals-pi

kartik

cam we used put back spread and call back spread as combination

You can, but I’m not sure what kind of Payoff you are likely to get. Please plot it on excel as a combined payoff and check.

I have done already u can see in the image it pay on either side on expiry

Sorry, dint notice that. This looks good.

Combining Put and call back spread: will it not be equal to 1 long straddle and 2 long strangle?

Both are bi directional strategy.

Well, the best way to validate that is by actually tracking the payoff.

sorry, it will be equivalent to 1 short straddle and two long strangles.; Right?

Dear mayur,

Can you please mail the file at [email protected]. Thanks a lot brother,,,, I was having excel difficulty in plotting the same..

Boy, Dont fall for condors and or butterflies stratgies. Those are very complicated. Stick to basic strategies and only go for two leg strategies.

Sir how much money margin is requiersd i mean to say.. Only for 45 points credit is required or for entire all three options

In this example yes.

Here is the question , if i am out right bullish on index/stock and targets will be met with a day or 2, why call ratio back spread ? When option trader is implementing more than 2 legs option stratgey, its clear he is not fully sure of market movements.

There is nothing like ‘fully sure’ in the market, hence risk averse traders depend upon strategies such as this.

Sir my Question is How to calculate stock strike price . please give me the simple example

Why do you need to calculate strike price? NSE will do that for you based on their strike creation logic.

Hi Karthik, how do we calculate and plot profitability charts to deduce best strikes.

No need to plot, I’s suggest you identify the strikes keeping the Greeks in perspective.Check this chapter – http://zerodha.com/varsity/chapter/re-introducing-call-put-options/

Hi Karthik,

Graphs are not appearing. Its been replaced by a placeholder. Could you please take a look?

Thanks in advance,

~Abhijit

Seems to be working fine, can you please refresh the page and confirm? Thanks.

What would be the effect it we change ratio to 2:1 to Some other Ratio??

And Could basis of change ratio depend on??

Well you are change it to any number but have the maintain the 2:1 ratio. The higher the number of lots, the higher is the degree of gains/loss.

Hi Karthik,

For a interday trader, do you think its better to go with naked options or use any of the strategies from this module?

Thank You

Intraday I’d suggest naked options…unless its event driven.

Hi Karthik,

Can you please provide more information(or resources to study) on the effect of volatility and option greeks on the strategies discussed in this chapter. For example i didnt understand how you are able to generate the images shown in the section “4.4 – Welcome back the Greeks” of this chapter. So please tell me where can I find more info on these.

Thanks!!

All the graphs are generated based on B&S model. Once you build the model you can tweak a variables/against others to get any desired output/graphs.

I understand that B&S model will take some parameters as input and compute the option greeks values(Please correct me if i am wrong). But in section “4.4 – Welcome back the Greeks” of this chapter, you have shown a graph between strike vs profit Loss %. Please tell me how you were able to plot this graph.

Also please let me know if there are any tools to build the B&S model.

Thanks

Yup, these graphs were developed using the B&S model. Also, if i’m not wrong these were developed using ‘R’ software.

I tried to google on how these graphs can be generated using B&S model, but i couldn’t find any helpful resource. Can you please give me any reference on how to use the B&S model to generate these graphs.

Also i tried searching for the “R” software. As far as i understand it is a programming language. Is my understanding correct?

If you are using “R” programming language, please provide the references for this as well.

Thanks!!

Yes, R is a statistical package. All about R here – https://www.r-project.org/about.html

Cannot visualise your graphs on the iPad. Where are these graphs available for us to make a decision.

You need to develop the payoffs on excel.

Which is the software/website wherein these graphs would be available for reference?

Hopefully, we will have one on Zerodha sometime soon 🙂

Mr. Karthik,

“4.4 – Welcome back the Greeks”

Assuming Nifty moves from 8000 to 8500, Graph-1 shows 7800 CE as the most profitable strike. But, As per our strategy we will be losing money as we have short 7800 CE.

In that case what shall be the best strike to choose to get good profit from Call Ratio Back Spread strategy.

Can you clarify.

Sorry, I’m unable to get the context here. Can you kindly elaborate?

In 4.2 Strategy Notes:

You have chosen to sell one lot 7600 CE and buy 7800 CE, when we expect Nifty to move from 7743 to 8100.

In 4.4:

Nifty at 8000 and assuming it to hit 8500 the most profitable strike is 7800 CE as per the stats. But when we plot this strategy when Nifty is at 8000, we have to Sell one lot of 7800 CE and Buy 2 lots of 8100 CE.

The graph shows 7800 CE (1 lots) as most profitable strike, which we have short.

In that case 7800 CE will give us loss as it will react more than two lots of 8100 CE.

I am slightly confused to understand.

We need to consider time as well..and not really look at this at an individual strike level bur rather at a strategy level. So please look at the time to expiry and see which graph suits the situation.

Considering i am at the first half of the month.

As mentioned “7800 CE (ITM) and 8100 CE (OTM) is the most profitable wherein you would sell 7800 CE and buy 2 8100 CE”

But the graph shows 7800 CE as the most profitable strike (which we have short)

Raj – You will have to see it as a strategy as a whole, and not at individual strikes.

Dear Karthik,

If we have to implement multileg strategy, exactly how to do it on Z pi platform. Do we have to implement one by one. In such case, will not the platform identify them as separate trades? Can you please throw light one this.

Regards

We do not that yet, you will have to place order for each leg of the trade.

Images are not available on this page

Its loading very well here. Which images are you talking about?

2 questions

1) if we buy call option if we hold it till expiry is there any extra charges like STT.

2) if we short call option or put option can we squared off trade before expiry?

1) If the option turns ITM, then yes. Check this – http://zerodha.com/z-connect/queries/stock-and-fo-queries/stt-options-nse-bse-mcx-sx

2) Yes, you can.

Hello sir,

What if we buy a put option instead of selling a call option at that specific strike.

Our overall expense would increase but our profitability would also increase if the market reverses.

What other difference would it make???

You should look at selling Call options (as an alternate to buying puts) when the premiums have shot up significantly. Naturally, buying PUTS would also be expensive at this stage.

Sir I have 1 sell option and 2 buy options of call for yes bank stock. Do I get the profit / loss based upon premium for 1 lot shares or 3 lot shares..? Max loss here is 12 rs. Whether its 12 * 1 lot shares or 3 lot shares.

If you have executed this as a strategy, then you will have to consider the P&L for the entire lot, which included 3 positions.

Hi,

“Welcome back the Greeks” Diagrams are not visible.

-MS

Can you refresh your browser and check again, please?

Hello, they are not visible. Even after refreshing the browser.

How does it matter if target is hit in 5 days or 15 days… dont we have to wait till expiry to square off the trade anyways ?

Not really, you can sq off the position whenever you want. Have explained in the comments earlier.

But if you square off 10 days before the expiry then premium wont be equal to intrinsic value… it will have time value also.. so profit and loss will be different wont it ?

Yes, it would be. When you are trading before expiry, you are essentially trading the premium or the difference between your buy and sell price of the premium.

Hi I see little mistake in the excel sheet, looks like column PP is not calculated twice so it is showing only 1 leg debit so the chart itself is not showing correctly. Can you correct it

Premium Paid for both the lots is 156, which is what is in the Excel sheet.

Don’t see any errors, Vijay

Hi Karthik/Faisal,

You guys are awesome and you know it already.

I have a query:

I prepared 2 cases for March expiry at current levels.

Case 1: standard Call-Ratio-Back-Spread

Case 2: Instead of 2 lot I went long with 1 lot.

What I observed is that, in case 2:

Maximum loss decreased, breakeven span for loss reduced, profits increased. In fact everything seems positive.

Please enlighten.

not able to attach snap.

Case 1:

Underlying Nifty

Spot Price 10094

Lower Strike (LS), Sell, ITM 9900

Higher Strike (HS), Buy, OTM 10200

Credit (LS) 250

Debit (HS) 2*61

Net Credit 128

Case 2:

Underlying Nifty

Spot Price 10094

Lower Strike (LS), Sell, ITM 9900

Higher Strike (HS), Buy, OTM 10200

Credit (LS) 250

Debit (HS) 61

Net Credit 189

Sushant, while case 1 is a standard ratio spread, what you have in case 2 i.e sell ITM Call and buy OTM Call is called a ‘Bear Call Spread’. Essentially this is a variant of bull call/Put spreads. Works best if you expect the stock/index to fall. I’d suggest you plot the payoff graph and visualize the P&L to understand this better.

As per the chapter we have to maintain 2:1or ( 2n:n ).

Are there strategies which has different ratios such as (m:n) where m&n can be any number ?

No, as far as I know, most of the options strategies have a predefined ration within which you have to execute the trades.

Hi Karthik none of the images in section 4.4 is visible. Only Zerodha watermark can be seen. Can you please look into this?

Can you please check again? It seems to be working fine!

Sir

Section 4.4 images are not showing.

Can you please refresh and check again? It is working fine for me.

Hi Karthik,

Thanks a lot for Varsity.

I wanted to know that instead of waiting till expiry for this strategy to work, if I trade the options based on the premiums at any time before expiry to book profit, will the profit/loss graph remain the same or it may change based on other factors like volatility, delta etc which in turn will alter the premiums.

Thanks.

The P&L will vary, Rishab and it largely depends on the option greeks.

Okay.

Does that mean that even though my view is bullish and the stock/index does move upwards, I can still make a loss if other Greeks don’t work out in my favor ? (Before expiry)

Also, all option strategies will be surely profitable only if my view of the stock/index remains correct till expiry of the contract ?

Yes, there are instances where the stock moves in your direction but other factors drag the premiums lower. So you need to be completely aware of the greeks influences on the options.

Okay.

One more thing. During the contract period before expiry, the spot value will keep changing which may change the moneyness of the options bought/sold. So, do we need to keep updating them accordingly or we should hold them based on the initial spot price ?

I hope I am not irritating you too much with my questions!

Rishab, its always a good idea to keep the sheet updated. Moneyness of the option is dynamic and has a great impact on option premiums. It is best to be aware of the current market situation.

Okay Sir. Thanks.

Welcome!

Hello sir, I was randomly checking payoff structure for ashok leyland today sir,

spot price = 145

strike 142.5CE MAY = 4

strike 140CE MAY = 5.95

if I apply the above strategy then net cash flow will be debit of 2.05 (4 * 2 – 5.95)

I double checked the option chain for premium values. Even for Maruti twice the premium for slightly ITM is higher than deep ITM option sir.

Yes, but you may not really want to write an ITM option, especially when you are so close to expiry.

ok sir.

Hello Sir, is there any delta limit that has to be maintained while executing this strategy? net delta works out to be 0.2, is it okay or should I increase the spread to change the delta value?

If you are looking at Delta neutral, then it should be in and around 0…so something like -0.1 to 0 to +0.1 is ok. 0.2 is slightly skewed towards long side.

Images in the section 4.4 are not visible. Please do the needful.

Can you refresh the browser once and reload the images?

I have refreshed but still not working. Below image is not working:

https://zerodha.com/varsity/wp-content/uploads/2015/12/Image-3_start-of-the-series.png

But rest of the images are working fine like below one can be seen correctly.

https://zerodha.com/varsity/wp-content/uploads/2015/12/Image-2_Payoff-graph.png

Will check this, Sumit. Thanks.

Hi,

The attached strike price graphs are not visible/empty. Please look into this

Can you please refresh the browser once? Thanks.

The payoff graphs are still not visible. I am using Mac OS and chrome browser. Please look into it.

I’m really not sure why, I just got this checked on a Mac, and it seems to be working fine. Can you please try a browser hard refresh? Thanks.

Hi,

What do you think about this practice trade.

Wipro spot 282

Sell 275 CE @ 13.65

Buy 285 [email protected] 8.30

As wipro will post result on july 20 so i am expecting directional move on any side instead of range bound. And although volatility is bit high but i am expecting volatility to increase due to event .i have already drawn p/l on excel so closing beyond 280-290 range level will be profitable.

I’d suggest you track volatility closely, my guess is that it will drop post the event 🙂

sir,

shouldn’t the premium increase with increase in volatility even though there are still 5 days to expiry.in that case the possibility of call options transitioning to ATM from OTM increase or you mean to say that irrespective of the strike theta simply supersedes the volatility impact and hence the premium decreases.pls clarify sir!!

The three variable i.e premium, theta, and volatility act simultaneously. If there are more days to expiry, then with the increase in volatility, the premium increases. If there are less (fewer) days to expiry, then the impact of an increase in volatility has a lesser impact on the premium. What matters here is the decay in time i.e the theta. To understand their dynamics, peg 1 of the variables like I have pegged time in this explanation.

Hi ,

Considering you execute this strategy and and market rises. Here the OTM options make money . As ITM options were sold will we lose money faster here due to high delta value?

Hence the 1:2 ratio.

For intraday is it ok if we go with 1:1 ? If we go with 1:2 then it becomes net debit. And if the market is range bound then p&L is showing negative.

Also for intraday trading do we have to calculate the intrinsic value in the excel sheet

Sure, Shyam, as long as you keep an eye on the SL 🙂

In the current market scenario it looks like breakeven is at 11500 if we sell an 11200 ITM CE and buy 11400 OTM CE. Profit will be when nifty is at 11550. Loss will be when market is range bound betwen 11300 and 11500.

Can we sell a ITM option and buy a ATM option instead of buying a OTM option?

You can replace the OTM with ATM, this will increase the cost but reduce the breakeven and the overall profitability of the strategy. Please make sure you are comfortable with the risk and reward. Good luck.

Hi Karthik,

Can we exit from all positions (Buy and Sell options) without waiting for expiry of Option ?

Thanks in advance

Yes, you can.

dear sir,

unable to see the pictures in

‘ welcome back the greeks ‘

Can you do a hard refresh and check again? Thanks.

SIr ,

can you as per your line below.

1.how to judge if volatility is on higher side ?? or know how much higher it is from general mean

2. does volatility vary of each strike different or same as underlying ( how to know change in Volatility ) ??

“I would be a bit hesitant to deploy this strategy at the start of the series if the volatility is on the higher side (say more than double of the usual volatility reading)”

1) YOu can compare the current vol with historical vol to get a sense of where the volatility stands for now. This is a rough technique, but works

2) Yes, it does

Whether one should wait till the expiry to workout the strategies or can we square off in between if the target is achieved.

You can square off anytime you want.

Hi sir,

Could you please confirm is it possible to use the SL and SLM option in kite for Call or Put options.

You can use SL order type to place your Stoplosses. SLM is not possible for stock options.

However, you can use both for Nifty and Banknifty options

Sir,

In call ratio back spread strategy, is there any chance that the max loss may increase in any circumstances. I mean is it guarantee that the maximum loss will be Max Loss = Spread – Net Credit.

Or it may fail if any adverse happens/ whatever changes in the greeks?

Kindly clarify as i am eager to apply this strategy.

Also i request you to add a window in kite for one click execution of Option strategy instead of putting seperate orders for both legs.

Not really, Nithin. The max loss is already predefined in this strategy. Sensibull is working on this feature.

There is some error in excel sheet provided. For higher strike PP ( premium paid ), it should be for 2 lots. Instead it was accounted only for one lot. When the price goes down intrinsic values goes down so it is 0 and its ok. At the same time the premium paid should also be doubled. Please correct. It would be useful for others.

I’ve multiplied the premium with 2, so that takes care. Check cell D9.

Dear Karthik,

All the figures/graphs under the topic ” 4.4 – Welcome back the Greeks ” are not visible. Can you please update the graphs.

Thank you Sir.

Seems to be working fine for me, Ron. Can you do a hard refresh of your browser and check again? Thanks.

Hi Karthik,

What is the benefit of implementing “Call Ratio Back Spread” when we get additional benefit of unlimited profit on downside as well by implementing “Long Straddle/Strangle”? Leaving the technicalities like this is preferred when movement in one direction is opined and the other is when it’s bidirectional. But i still don’t see the benefit of letting go the unlimited profit on downside as well by implementing this strategy.

I can see the only benefit is net credit when this strategy is implemented but again margin needs to be maintained for shorting.

Vishal, you implement this, when you are bullish, unlike long straddle/strangle where you are neutral about markets. The good part, as you said is the net credit on the lower side, in case you are wrong about the bullish outlook.

Hi Karthik

My question is net credit will happen only if ITM (1 selling) is higher combined both the OTM?

1) For eg selling 1 lot of 10500 CE ITM 332.30*75=24922

2) Buy 2 LOTS OF 10950 CE OTM 86*150=12900

Hence net credit will be 24922-12900=12,022

Am i right ?

That’s right, you should receive far higher than what you pay for. This is when net credit happens.

In addition to the above question, say for eg i will execute the above strategy at 10: AM in the morning will I be able to square it off after 5 minutes, and get the net credit as profit.

Yes, you can square off the position anytime you want.

Dear Karthik,

The last 3 graphs in this chapter is not visible. Kindly look into it.

Thanks and Regards,

Rajneesh

Seems to be working, Rajneesh. Can you try doing a hard refresh on your browser?

Hello sir, why you have not included chapter on, front ratio spread, i.e. buy less and sell more options. Is it not worthy or just because it is a strategy of unlimited risk(theoretically).???

Let me check, Amit.

Sir, did you???

Front spread is the exact opposite of Call Ratio back spread. The good part about this is the profitability is known across a large range (like call ratio back spread). This gives enough buffer for the downside risk. Use this when you expect the stock/index to remain in a range or go down.

Hello sir,

What if you are in a situation where the strategy turns out to be net debit instead of net credit.

eg.- spot price – 10,800

LS- (ITM)- 10,700 and premium= 296.30

HS (OTM)10,900 and premium= 167.30. and also I want you know how calculate or know the optimized spread.

Please help me in this.

How to calculate or get the optimized spread?*

Unfortunately, there is no formula for this. You will have to tweak this with few strikes.

In such cases, it would be best to select a few higher/lower strike to ensure the strategy gives you a credit. However, don’t force fit the strategy.

Hi Karthik, really great tutorials. Really the effort and explanation is appreciable.

Some how I am not able to view graphs after section 4.4 – Welcome back the Greeks

Thanks, Shukla. Can you try hard refreshing your browser?

Call ratio back spread

From 7600 to 7800 there will be lose always ??

What would happen if we cant buy two lot from the lower strike premium received so should we increase the spread size or should we spend some extra amount to buy the spread which we want to buy??

Gautam, the higher the spread the lower the profitability. So you really need to find a balance between the spread and profitability. Btw, why won’t be you be able to buy the lower strike? If liquidity is good, there shouldn’t be any problem, right?

u didnt understand the ques

lets say nifty 11600 ce 200 premium

and nifty 11800 ce 105 so here u see 105*2 =210 i didnt receive the premium in this case so what should i do then

Sorry, I’m still not able to get your query. Can you please elaborate? Thanks.

What should i do if i am not able to buy 2 lot with the premium i recived by selling a lower call option

Suppose i receive 100rs as premium by selling

And now i want to buy 2 lot which is 60rs per lot . Which will cost 120

. What should be done then

Ah, in that case, the credits (from selling the higher strike) don’t match the debit (required for buying options)…so you will have to fund the difference. There is no other way.

Hey Karthik,

I didn’t understand why would we consider Volatility in the call ratio back spread when we are going to hold till expiry and as we are holding till expiry only the intrinsic value would get traded and not the Premiums?

Please correct me:)

The strategy is net long, which means you have to ensure you buy when the volatility is low because the premiums are on the lower side.

Thank you Karthik. 🙂

You are amazing……….!!!!!!!!!!!

Lol 🙂

Thanks for the kind words!

Hey Karthik,

Suppose we are in the first part of the month and the target gets achieved in a day, so would we have to hold the trade till the expiry because to collect the premiums?

And if yes then what if for some another reason after the target is achieved the market drops then what would happen?

:))

No, you can sell it anytime before the expiry of the trade. No need to wait till expiry.

So would I be able to pocket the premiums when I short the option?

Yes, you will receive the credit of the premium for the option you’ve written, Ram.

Sorry Karthik I am not able to understand when the intrinsic value is traded and when the premiums are traded?

Like if one could sell a option and pocket the premium and buy it back instantly what would get traded the premiums or the intrinsic value? 🙂

Its the premium which always gets traded. Just that the value of the premium is derived from the intrinsic value of the option.

Hi Kartik,

Suppose banknifty is trading at 30600. If I make two positions like sold CE 31000 and sold PE 29500 just one day before expiry. And on the expiry day if spot value remains in between these two strikes, will I be making money?

Looks like, Amol. I’d suggest you try plotting the payoff on Excel to visualize and understand the strategy’s behavior better or you could try https://sensibull.com/.

Hello karthik,what is the meaning of the context “volatility is on the higher side ” please do clarify my doubt.

It simply means that today’s volatility is higher compared to historical volatility.

Hey Karthik,

Normally what is the average IV on Nifty stocks?

It varies across the stocks, Ram.

Thank You My Superhero!!!

sabka malik ek – the markets 🙂

Hi,

Ref; call ratio back strategy:

Pl check calculation for expiry at higher strike @7800 – double whammy point, loss should be RS 201+78×2 = 357. Pl do correction in chart and calculation. Thanks.

For 7600CE, 201 is the premium received, intrinsic value is 200, so this actually results in a net gain of 1. You’ve sold 2 lots of 7800CE at 78, so thats 156 in loss. Total loss is 156-1 = 155.

Am I the only one who can’t seem any images post Section 4.4 – Welcome back the Greeks?

Can you try doing a hard refresh on your browser?

Sir,

I am sorry as i may have missed it but from where do we get the graphs involved in selecting the strike prices?

Do you mean the option chain? It is available on Kite, click on the context menu available when you load a strike on the Kite’s Marketwatch.

Hi Karthik , Just great learning

I was working on the Nifty Bank and checking the strategy .

For me to get a net Credit i actually required a very big variance

Spot : 17477

Premium for 18700 CE : 603.75

Premium for 17300 CE : 1294.15

Nett Credit : 88

With such a big spread , can we actually make any money in this strategy

For any lower spread we are not getting any nett credit

Am i playing it wrong , or this strategy is best avoided for Bank Nifty or i am picking the wrong strikes

Cheers Aman

Underlying Index: BANKNIFTY 17477.00 As on Mar 23, 2020 12:34:25 IST

LTP Strike Price

1,419.95 17100

1,354.80 17200

1,294.15 17300

1,234.95 17400

1,163.00 17500

1,110.65 17600

1,056.05 17700

1,004.05 17800

956.65 17900

895.25 18000

845.05 18100

802.2 18200

751.05 18300

718.15 18400

686.3 18500

655 18600

603.75 18700

578.55 18800

551.3 18900

521.45 19000

490.85 19100

The problem is not getting the credit, it is about getting protecting it 🙂

If the market rebounds and starts making a comeback, you could be in trouble with this position.

The problem is not getting the credit, it is about getting protecting it 🙂 .. I am sorry this is not clear to me

I just want to know for this spread to work what is a favourable situation and which instrument is more suitable as Bank Nifty case which i tried , i could not use data to verify the hypothesis .

The payoff graph explains this well. You make a profit of mkt moves in any direction. You lose money if the market stay within the range.

Hello Karthik!

How do we plot volatility, payoff and time to expiry graphs? Can you please help with some resource?

Thanks!

You need to do this with a program, Arjun. Something like R or Python helps

Ok I cant see the graphs in sections welcome back the greeks even after performing hard refresh.

Ah, strange because it looks fine on my system.

Hello Karthik,

Would appreciate if you could kindly answer the flwg queries :

1. Does the ratio always have to be 2:1…. or can 3:1 could also be considered.?

2. Is having a Net Credit (rather than zero or negative) at the start of the strategy the key to profits?

3. As can be seen… the max loss occurs (at expiry) at the Long Strike Price (i.e 7800 ). Is there

a way to keep this loss to a minimum or mitigate this loss (during these volatile times) by initiating

a counter trade.?

This is indeed otherwise ‘an interesting options strategy’ as indicated in the tutorial.

Unlimited profits if the market rises… A limited profit when it falls…and a pre-defined loss when flat.

Thanks.

1) Can be in the ratio of 2:1…so 4:2 or 6:3

2) Not a key, but good if its that way

3) Hmm, you’ll have to offset this with writing options within that strike, gets a little messy though

Good luck!