Ratio Call Spread is the opposite of a Call Ratio Backspread in that we are net
short options. This means we are exposed to uncapped risk and can only make a
limited reward. As such, this is an undesirable strategy, and you would be
better off trading one of the long butterflies.
Ratio Call Spread involves buying and selling different numbers of the same
expiration calls. Typically we sell and buy calls in a ratio of 2:1 or 3:2, so
we are always a net seller. This gives us the uncapped risk potential. It also
reduces the net cost of doing the deal such that we create a net credit.
this strategy in a neutral to bearish environment when you expect decreasing
volatility and the stock to remain rangebound, when you are looking to generate
is trading at $27.65 on May 10, 2011.
one June 2011 25 strike call at $3.11.
two June 2011 $27.50 strike calls at $1.52.
you guessed correctly and the stock remains rangebound, net credit earned.
risk is unlimited. The reward is the difference in the strike prices plus the net
credit, multiplied by the number of long contracts.
risk if the stock increases in price.
even up: lower strike plus difference between strikes, multiplied by number of
short contracts, divided by number of short contracts minus number of long
contracts, plus net credit received or net debit paid.
even down: lower strike, minus net debit divided by number of long contracts.
volatility is negative because of our exposure to uncapped risk. The best thing
that can happen is that the stock does not move at all.
Of Time Decay
You are selling more contacts than you are buying. You want your exposure to be
preferably one month or less.
can close out the position if the stock increases above stop loss.
least one month in advance of expiration, close out the position to stem loss
and capture profit.
the position by buying back the calls sold and selling the calls bought.