Risk-Reward Ratio
Maximum potential loss versus maximum potential gain
What is Risk-Reward Ratio?
Risk-Reward Ratio The ratio of the maximum potential loss to the maximum potential profit of a trade. A risk-reward ratio of 1:3 means you risk $1 to potentially make $3. In defined-risk options spreads, this is easily calculated from the spread width and credit received. Lower ratios (less risk per unit of reward) are generally preferred.
Complete Definition
The ratio of the maximum potential loss to the maximum potential profit of a trade. A risk-reward ratio of 1:3 means you risk $1 to potentially make $3. In defined-risk options spreads, this is easily calculated from the spread width and credit received. Lower ratios (less risk per unit of reward) are generally preferred.
Example
A $5-wide credit spread collecting $1.50. Risk: $3.50 (width - credit). Reward: $1.50. Risk-reward: 2.33:1.
Related Terms
Want to Learn More?
Explore our educational resources and analytics tools to deepen your understanding.