Understanding The Call Ratio Spread Strategy – Net Debit

In this issue, we explore the Call Ratio Spread strategy in its Net Debit variant, a versatile approach for traders expecting moderate bullish market movement. Unlike the Net Credit variant, the Net Debit version requires an upfront investment but offers a more aggressive profit potential. Let’s dive into how our assumed trader Sarvani Shah employs the Call Ratio Spread (Sell More) to align with her current market expectations 

What is a Call Ratio Spread (Net Debit)?
The Call Ratio Spread (Net Debit) involves buying one in-the-money (ITM) call option and selling two out-of-themoney (OTM) call options. This creates a net debit position, meaning the trader pays a small upfront premium to initiate the trade. The strategy is designed to benefit from slight upward price movements in the underlying asset while maintaining a controlled risk structure. 

Why Call Ratio Spread (Net Debit)?
This strategy is ideal for traders who:
■ Expect Moderate Bullish Movement: Profits from small upward market movements.
■ Seek Defined Risk: Losses are limited to the net debit paid at entry, till market remains below the upper breakeven point.
■ Aim for High Reward Potential: Significant profit potential if the market aligns with the breakeven range. 

For Sarvani, the Call Ratio Spread (Net Debit) suits her outlook of a gradually rising Nifty with controlled volatility 

Executing the Call Ratio Spread (Net Debit)
Here’s how Sarvani structured her trade:
■ Nifty Current Market Price: ₹23,350
■ Buy 1 Lot ITM Strike 23,200 CE Price: ₹380
■ Sell 2 Lots OTM Strike 23,500 CE Price: ₹180 each
■ Expiry Date: January 30, 2024. 

Sarvani buys one ITM call at ₹380 and sells two OTM calls at ₹180 each, resulting in a net debit of ₹20 (₹380 paid - ₹360 received). 

Breakeven Points
The Call Ratio Spread (Net Debit) has two breakeven points:
1. Lower Breakeven Point (LBEP): Strike Price of Bought Call + Net Debit Calculation: 23,200 + 20 = ₹23,220.
2. Upper Breakeven Point (UBEP): Strike Price of Sold Call + Strike Price Difference - Net Debit Calculation: 23,500 + 300 - 20 = ₹23,780. 

Sarvani’s profit potential lies between ₹23,220 and ₹23,780 and her maximum loss is Un-limited if the market moves against her beyond upper breakeven point. 

Payoff Structure
The payoff for the Call Ratio Spread (Net Debit) depends on Nifty’s closing price at expiry:
1. If Nifty remains below ₹23,200 (ITM Strike):
■ All options expire worthless.
■ Sarvani incurs a loss equal to the net debit paid.
■ Maximum Loss: ₹20. 

2. If Nifty is between ₹23,200 and ₹23,780:
■ The sold OTM calls incur losses, offset by the bought ITM call.
■ Sarvani’s profit peaks near the strike price of the sold calls. 

3. If Nifty rises above ₹23,780 (Upper BEP):
■ The sold calls’ losses exceed the gains from the bought call.
■ Net Payoff = Gains from Bought Call - Losses from Sold Calls - Net Debit. 

This table shows Sarvani’s maximum profit of ₹280 is near 23,500 level, while her risk becomes unlimited above 23,780 level. 

Call Ratio Spread (Net Debit) versus Net Credit Variant
Both the Net Debit and Net Credit Call Ratio Spreads share the same foundational structure of buying fewer options than sold. However, they differ significantly in their cost, risk, and market suitability:
1. Cost Structure:
■ Net Debit Variant: Requires an upfront premium (debit) to enter the trade. This occurs because the cost of the bought ITM option exceeds the premium received from the sold OTM options.
■ Net Credit Variant: Starts with a net credit, as the premium received from selling more OTM options exceeds the cost of the bought ITM option. 

2. Breakeven Points:
■ Net Debit Variant: The upper breakeven point is closer to the current price, as the upfront debit narrows the profit zone.
■ Net Credit Variant: The upper breakeven point is farther, given the credit received at entry, which provides a buffer against small adverse movements. 

The choice between the Net Debit and Net Credit variants of the Call Ratio Spread hinges on the trader’s market outlook and risk appetite.
■ The Net Debit variant is ideal for traders willing to pay a small premium for higher profit potential in slightly bullish conditions.
■ The Net Credit variant is better suited for traders looking for an upfront credit, willing to trade capped profits for the ability to profit in range-bound or slightly bearish markets. 

Conclusion
The Call Ratio Spread (Net Debit) is a powerful strategy for traders like Sarvani, who expect moderate bullish movement with controlled volatility. Its defined risk structure within the breakeven range and potential for high returns make it an attractive option for cost-conscious traders. This strategy works effectively for indices like Nifty, where movement is more predictable within a range. However, traders must carefully monitor positions to avoid missing profit opportunities as the market approaches breakeven levels. By continually refining her understanding of various options strategies, Sarvani remains confident in her ability to navigate diverse market scenarios, ensuring her trading success over the long term.