Ratio Call Write: Understanding the Strategy, Examples, and Risk Analysis

Ratio call write is a nuanced options trading strategy employed by traders seeking to leverage their stock ownership. The primary objective is to capture additional premiums by selling more call options than the total shares owned. This strategic move hinges on the anticipation of minimal volatility in the underlying stock during the specified period. However, it comes with a tradeoff—potential profits are capped, and losses can be infinite, a characteristic feature of call options.

Options, as derivative contracts, grant investors the right to buy (call options) or sell (put options) securities at predetermined prices in the future. In the context of ratio call writing, the ratio denotes the number of options sold for every 100 shares owned in the underlying stock. For example, a 3:1 ratio call write involves writing three call option contracts while holding one hundred shares of the asset.

The payoff structure resembles a traditional covered call but with an amplified profit potential. Simultaneously, the risk increases, as the investor holds a 1:1 covered call position and is short two additional naked calls, exposing them to unlimited loss potential.

The profit range for ratio call writes is often narrow, leading to capped potential gains. A significant drop in the stock price can result in substantial losses exceeding the collected premiums. Conversely, if the underlying shares’ price surges significantly, the trader may also incur losses.

Ratio call write falls under the broader category of options strategies known as buy-writes. It shares similarities with covered calls, where the owner sells call options at an equal or higher strike price, albeit with a distinction in the ratio of options sold.

To illustrate, consider a hypothetical scenario with Company XYZ. An investor owning 1,000 shares decides to sell 25x of the 60 strike call options in a ratio call write, amplifying their profit potential. Profitability is maintained as long as the stock remains below $60. However, a substantial rise in XYZ’s stock price beyond $60 can lead to losses due to the unhedged nature of the long stock position against multiple in-the-money (ITM) short calls.

While both involve selling call options against stock ownership, ratio call write differs by selling more call options than the total shares owned, amplifying profit potential but increasing risk.

The profit range is narrow due to the capped potential gains and the possibility of substantial losses in case of a significant drop in stock price.

Yes, ratio call write can be applied to any stock where options trading is available. The suitability depends on the trader’s risk tolerance and market analysis.

If the stock price rises substantially above the strike price, the investor may incur losses as the long stock position is not fully hedged against the larger number of in-the-money (ITM) short calls.