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TABLE 11-2.
Ratio write and ratio spread compared.
Profit range
Maximum profit
Downside risk
Upside risk
Initial investment
Ratio Write:
Buy XYZ of 50 and
Sell 2 July SO's at 5
40 to 60
10 points
40 points
40 points
$3,000
Part II: Call Option Strategies
Ratio Spread:
Buy 1 July 40 of 11 and
Sell 2 July SO's at 5
41 to 59
9 points
1 point
Unlimited
$1,600
In Chapter 6, it was pointed out that ratio writing was one of the better strate­
gies from a probability of profit viewpoint. That is, the profit potential conforms well
to the expected movement of the underlying stock. The same statement holds true
for ratio spreads as substitutes for ratio writes. In fact, the ratio spread may often be
a better position than the ratio write itself, when the long call can be purchased with
little or no time value premium in it.
RATIO SPREAD FOR CREDITS
The second philosophy of ratio spreads is to establish them only for credits.
Strategists who follow this philosophy generally want a second criterion fulfilled also:
that the underlying stock be below the striking price of the written calls when the
spread is established. In fact, the farther the stock is below the strike, the more
attractive the spread would be. This type of ratio spread has no downside risk
because, even if the stock collapses, the spreader will still make a profit equal to the
initial credit received. This application of the ratio spread strategy is actually a sub­
case of the application discussed above. That is, it may be possible both to buy a long
call for little or no time premium, thereby simulating a ratio write, and also to be able
to set up the position for a credit.
Since the underlying stock is generally below the maximum profit point when
one establishes a ratio spread for a credit, this is actually a mildly bullish position.
The investor would want the stock to move up slightly in order for his maximum prof­
it potential to be realized. Of course, the position does have unlimited upside risk, so
it is not an overly bullish strategy.