Variable Ratio Write
What Is a Variable Ratio Write?
A variable ratio write is a strategy in options investing that requires holding a long position in the underlying asset while at the same time composing various call options at different strike prices. It is basically a ratio buy-write strategy.
The trader's goal is to capture the premiums paid for the call options. Variable ratio writes have limited profit potential. The strategy is best utilized on stocks with minimal expected volatility, especially in the close to term.
Understanding Variable Ratio Writes
In ratio call composing, "ratio" addresses the number of options sold for each 100 shares owned in the underlying stock.
For instance, in a 2:1 variable ratio write, the trader could possess 100 shares of the underlying stock and sell 200 options.
Two calls are written: One is "out of the money." That is, the strike price is higher than the current value of the underlying stock. On the other, the strike price is "in the money," or lower than the price of the underlying stock.
The payoff in a variable ratio write looks like that of a reverse strangle. In the options trade, any strangle strategy includes buying both a call and a put on a similar underlying asset.
The variable ratio write is suitably depicted as having limited profit potential and unlimited risk.
Variable ratio writes have limited upside and unlimited downside.
At the point when the Variable Ratio Write Is Used
As an investment strategy, the variable ratio write ought to be stayed away from by unpracticed options traders as it is a strategy with unlimited risk potential.
The losses start in the event that the stock's price takes a strong action to the upside or downside past the upper and lower breakeven points set by the trader.
There is no restriction to the maximum conceivable loss on a variable ratio write position. Regardless of its huge risks, the variable ratio write technique can bring the accomplished trader a fair amount of flexibility with managed market risk while turning out appealing revenue.
There are two breakeven points for a variable ratio write position. These breakeven points can be found as follows:
Genuine Example of a Variable Ratio Write
Consider an investor who possesses 1,000 shares of the company XYZ, currently trading at $100 per share. The investor accepts that the stock is probably not going to move a lot over the course of the next two months.
The investor can hold onto the stock despite everything earn a positive return on it while it stays static in price. This is accomplished by starting a variable ratio write position, selling 30 of the 110 strike calls on XYZ that are due to lapse in multi month's time. The options premium on the 110 calls is $0.25, so our investor will collect $750 from selling the options.
That is, assuming the investor is right in anticipating that the stock's price will stay flat.
Following two months, in the event that XYZ shares stay below $110, the investor will book the whole $750 premium as profit, since the calls will be worthless when they lapse.
In the event that the shares rise over the breakeven $110.25, in any case, the gains on the long stock position will be more than offset by losses by the short calls. The options addressed 3,000 shares of XYZ, triple the number that the trader claims.
Features
- A variable ratio write is an options strategy utilized by traders who look for a side source of income for a stock that they own.
- The trader puts resources into numerous call options at different strike prices.
- The potential profit is in the premiums paid for the call options.
- The strategy is utilized when a trader thinks the stock will stay static in price for some period of time.
