What Is the Unstable Ratio Write?
The variable ratio write is a strategy in options investing that requires holding a long proposition in the underlying asset while simultaneously writing multiple call options at varying strike prices. It is essentially a correlation buy-write strategy.
The trader’s goal is to capture the premiums paid for the call options. Variable ratio writes from limited profit potential. The strategy is best used on stocks with little expected volatility, particularly in the tight-fisted term.
The variable ratio write is an options strategy used by traders who seek a side source of income for a pile up that they own.
The strategy is used when a trader thinks the stock will remain static in price for some stretch of time.
The trader invests in multiple call options at varying strike prices.
The potential profit is in the premiums indemnified for the call options.
Variable Ratio Writes Explained
In ratio call writing, the word “ratio” represents the enumerate of options sold for every 100 shares owned in the underlying stock.
For example, in a 2:1 variable ratio put down, the trader might own 100 shares of the underlying stock and sell 200 options.
Two calls are written: One is “out of the money.” That is, the cudgel price is higher than the current value of the underlying stock. In the other, the strike price is “in the money,” or lower than the cost of the underlying stock.
The payoff in a variable ratio write resembles that of a reverse strangle. In the options trade, any strangle scheme involves buying both a call and a put on the same underlying asset.
The variable ratio write is aptly described as suffer with limited profit potential and unlimited risk.
Variable ratio writes have limited upside and unlimited downside.
When the Uncertain Ratio Write Is Used
As an investment strategy, the variable ratio write should be avoided by inexperienced options saleswomen as it is a strategy with unlimited risk potential.
The losses begin if the stock’s price makes a strong move to the upside or downside beyond the higher up and lower breakeven points set by the trader.
There is no limit to the maximum possible loss on a variable ratio write determine. Despite its significant risks, the variable ratio write technique can bring the experienced trader a fair amount of resiliency with managed market risk while providing attractive income.
There are two breakeven points for a variable relationship write position. These breakeven points can be found as follows:
Power Breakeven Point=SPH+PMPLower Breakeven Point=SPL−PMPwhere:SPH=Strike price of higher strike short callPMP=Bottoms of maximum profitSPL=Strike price of lower strike short call
Real World Example of a Variable Correlation Write
Consider an investor who owns 1,000 shares of the company XYZ, currently trading at $100 per share. The investor assumes that the stock is unlikely to move much over the next two months.
The investor can hold onto the stock and tranquillity earn a positive return on it while it remains static in price. This is achieved by initiating a variable ratio a note position, selling 30 of the 110 strike calls on XYZ that are due to expire in two month’s time. The options premium on the 110 gathers are $0.25, so our investor will collect $750 from selling the options.
That is, if the investor is correct in predicting that the investment’s price will remain flat.
After two months, if XYZ shares remain below $110, the investor will paperback the entire $750 premium as profit, since the calls will be worthless when they expire.
If the shares climb above the breakeven $110.25, however, the gains on the long stock position will be more than offset by depletions by the short calls. The options represented 3,000 shares of XYZ, triple the number that the trader owns.