Write is an option strategy that involves stock ownership, but the stock
holder does not expect much movement before option expiration.
option-info and options-graphs sites:
Outlook: Neutral. Not expecting any dramatic move in the near term.
Buy stock, sell twice the equivalent number of calls, at the strike
price nearest the current stock price.
when: Stock stays between the breakeven points.
Gain: Limited to the option credit (during the life of the options).
when: Stock moves beyond one of the breakeven points.
Loss : Unlimited on both the downside and the upside.
Calculation: Lower breakeven = strike price - option credit. Upper
breakeven = strike price + option credit.
compared to stock: Increased leverage, less capital required, can
gain from little or no movement in the stock price.
compared to stock: Unlimited loss is possible to the upside as well
as the downside.
after entry, increasing implied volatility is negative.
after entry, the passage of time is positive if stock price is between
the breakeven points.
Requirement : Your broker will see a covered call, requiring no margin,
plus naked short calls. You need a permission level to trade naked options,
and the margin will be at least 10% of the strike price x the number of
shares represented, but probably more. See the bottom of the page for
Equivalent: Short Puts and Short Calls at the ATM strike (A Straddle
this strategy has unlimited risk to the upside as well as the downside,
you want to avoid volatile stocks, earnings dates, buyout candidates,
etc. You would want to use stock and options in a large stable company,
not likely to receive a buyout offer, and not in an earnings month.
- This strategy
might be suitable for someone experienced and successful with the Covered
Call strategy. It amounts to bringing in twice the premium of an
ATM Covered Call, having more "downside protection", and still
being able to hold the stock IF the stock does not move much before
- This is
type trade. The intent is to gain from the passage of time, and not
from stock price movement.
- The best
time to enter this trade is when volatility is higher than normal. A
higher than normal volatility means you will receive more for selling
the two calls, and that will result in a wider spread between the breakeven
points. It also increases the chances that the trade will gain from
both the passage of time and a drop back to normal in the volatility.
- A very
similar strategy, with limited risk, is the Butterfly.
- The trader
using a Ratio Write is expecting the stock to do nothing until expiration.
If the stock rises or falls, it is usually wise to exit the trade, taking
less than the maximum possible loss. You might plan to exit if the stock
got to either of the breakeven points at any time.
- If the
stock rises to the upper breakeven, taking a very small loss is possible
by buying back one short call, and allowing the other short call to
call you out of the stock at expiration. In the example trade, if the
stock gets to $53.96 in two weeks, an options calculator shows the 50
strike call will be worth about $4.25. So you took in $396, spend $425,
and your loss is just $29. This is not a guaranteed outcome however:
the stock could whipsaw and cause a loss on the downside. It would be
safer to exit the entire trade with a loss of about $58.
- Like other
Delta-Neutral trades, it
can be a good idea to take gains early. If the stock is at $50 in two
weeks, a gain of over $100 could be taken. Waiting another two weeks
puts any gain at risk from smaller and smaller movements in the stock
- If the
stock rises to the upper breakeven, it is possible to buy more stock
at that price, so that the position becomes two covered calls. If you
allow yourself to get called out at expiration, the whole trade is a
wash except for commissions. You took in $396 in premium and you will
lose $396 on 100 shares.
It is possible
to use this strategy if you do not have the option permission level to
trade naked short options, but you do have the permission level to use
spreads. This is accomplished by buying some very cheap protection for
the upside, as shown in the graph below. The margin requirement on the
example shown would be $1000 (100 shares uncovered (represented by 1 short
call) x $10 difference in strike prices).
If you want
to protect the downside as well, you are better off just using the Butterfly
strategy, for much less of a total debit (or a credit, depending on the