The idea behind the call ratio backspread is to use one trade to pay for a later trade. In the most popular version, the trader sets up both a short call spread for strike A and a long call for strike B. If it works as planned, the short call spread will cover the cost of the long call.

That’s why this spread is also called the pay later call. The investor makes the first trade on the margin with the expectation that the first strike will cover the cost of the second play.

This is a very risky strategy that only works when a stock gains in price quickly. It is usually used in bull markets and on fast-rising stocks. Many investors try to use this strategy on historically volatile stocks such as Tesla, hence the strategy’s other popular name—the ratio volatility spread.

A Very Profitable Strategy

Even though it is extremely risky, the call ratio backspread is very popular because it can make a lot of money fast if it works. This strategy has become real popular in recent years because of the extremely volatile market.

Another reason why the call ratio backspread has become so popular is the appearance of a few stocks with extremely high share prices. Stocks like Google and Apple often move erratically. That makes them ideal for a call ratio backspread strategy.

The strategy is usually set to take advantage of a momentary loss and a long-term gain. If you watch the financial news carefully, you’ll notice that a lot of the high-value stocks behave in that fashion these days.

Some experts have noted that the potential profits from a call ratio backspread can be unlimited. Although, they also note that incidents of such unlimited profits are actually quite rare.

Not for the Faint of Heart

The call ratio backspread is for gamblers and risk takers only because it is one of those strategies designed for a specific set of circumstances. If the circumstances do not occur, the strategy doesn’t work and the trader loses money.

Theoretically, the only losses here are supposed to be the net debit paid, but they could be greater. Those who hit the net debit paid will reach the breakeven mark. Unfortunately, it is possible to not hit that mark at all.

When the Call Ratio Backspread Will Not Work

Basically, for the call ratio backspread to work, the share price has to shoot up fast. If the share price doesn’t keep going up at a high speed, the strategy collapses.

That happens more often than many traders like to admit because this strategy only works with very volatile stocks. Any negative news story about a company or its shares can wreck this strategy.

On the other hand, the strategy can work well if a person suspects popular wisdom about a stock is wrong. An example of that might be a trader that thinks a company is about to release a much better earnings statement than analysts have predicted.

Who Should Use the Call Ratio Backspread?

The call ratio backspread is a very risky strategy for experienced traders that can afford to lose money. If you cannot afford to lose what you’re trading, you should stay away from this strategy.

You should also stay away from this strategy if you have to buy options on the margin. There are simply too many things that can go wrong to make this a safe margin strategy.

Beginners should stay away from the call ratio backspread because it is a complex and highly risky strategy. A better strategy for beginners would be to place individual short call spreads and long calls and learn how each of those strategies works before attempting this maneuver.

On the other hand, if you’re a very experienced trader who is certain of gains for a particular stock, you might try the call ratio backspread. When it works, it is a lot of fun, and it can be very profitable.