DEFINITION of Variable Ratio Write
The variable ratio write option strategy includes an investor holding a long position in the underlying asset while simultaneously writing multiple call options at varying strike prices.
Variable ratio writes have limited profit potential because the trader is only looking to capture the premiums paid for the call options. This strategy is best used on stocks with little expected volatility, particularly in the near term.
BREAKING DOWN Variable Ratio Write
In ratio call writing, the ratio represents the number of options sold for every 100 shares owned in the underlying stock. This strategy is similar to a ratio call write, but instead of writing at-the-money calls, the trader will write both in the money and out of the money calls. For example, in a 2:1 variable ratio write, the trader will be long 100 shares of the underlying stock. Two calls are written: one is out of the money and one is in the money. The payoff in a variable ratio write resembles that of a reverse strangle.
As an investment strategy, the variable ratio write technique should be avoided by inexperienced options traders as this strategy has unlimited risk potential. Because losses begin when stock price makes a strong move to the upside or downside beyond the upper and lower breakeven points, there is no limit to the maximum possible loss on a variable ratio write position. Although the strategy appears to present significant risks, the variable ratio write technique does offer a fair amount of flexibility with managed market risk, while providing attractive income for an experienced trader.
There are two break-even points for a variable ratio write position. These breakeven points can be found as follows:
- Upper Breakeven Point = Strike Price of Higher Strike Short Call + Points of Maximum Profit
- Lower Breakeven Point = Strike Price of Lower Strike Short Call - Points of Maximum Profit