Chapter 12: Combining Calendar and Ratio Spreads 225 
time (they would be at parity), there would be a debit of½ point to close the ratio 
spread. The two April 50 calls would be bought for 6 points and the July 50 call sold 
for 5½ - a ½ debit. The entire spread transaction would thus have broken even, less 
commissions, at 53 at April expiration, since the spread was put on for a ½ credit and 
was taken off for a ½ debit. The risk to the upside depends clearly, then, on how 
quickly the stock rallies above 50 before April expiration. 
CHOOSING THE SPREAD 
Some of the same criteria used in setting up a bullish calendar spread apply here as 
well. Select a stock that is volatile enough to move above the striking price in the 
allotted time - after the near-term expires, but before the long call expires. Do not 
use calls that are so far out-of-the-money that it would be virtually impossible for the 
stock to reach the striking price. Always set up the spread for a credit, commissions 
included. This will assure that a profit will be made even if the stock goes nowhere. 
However, if the credit has to be generated by using an extremely large ratio - greater 
than 3 short calls to every long one - one should probably reject that choice, since 
the potential losses in an immediate rally would be large. 
The upside break-even point prior to April expiration should be determined 
using a pricing model. Such a model, or the output from one, can generally be 
obtained from a data service or from some brokerage firms. It is useful to the strate­
gist to know exactly how much room he has to the upside if the stock begins to rally. 
This will allow him to take defensive action in the form of closing out the spread 
before his break-even point is reached. Since a pricing model can estimate a call 
price for any length of time, the strategist can compute his break-even points at 
April expiration, 1 month before April expiration, 6 weeks before, and so on. When 
the long option in a spread expires at a different time from the short option, the 
break-even point is dynamic. That is, it changes with time. Table 12-1 shows how 
this information might be accumulated for the example spread used above. Since 
this example spread was established for a ½-point credit with the stock at 45, the 
break-even points would be at stock prices where the spread could be removed for 
a ½-point debit. Suppose the spread was initiated with 95 days remaining until April 
expiration. In each line of the table, the cost for buying 2 April 50's is ½ point more 
than the price of the July 50. That is, there would be a ½-point debit involved in 
closing the spread at those prices. Notice that the break-even price increases as time 
passes. Initially, the spread would show a loss if the stock moved up at all. This is to 
be expected, since an immediate move would not allow for any erosion in the time 
value premium of the near-term calls. As more and more time passes, time weighs