Variable Ratio Write
A variable ratio write is a strategy in options investing that requires holding a long position in the underlying asset while simultaneously writing multiple call options at varying strike prices. It is essentially a ratio buy-write strategy.The trader's goal is to capture the premiums paid for the call options. Variable ratio writes have limited profit potential. The strategy is best used on stocks with little expected volatility, particularly in the near term.
Definition: Variable ratio writing is an options investment strategy that involves holding the underlying asset while simultaneously writing multiple call options with different strike prices. Essentially, it is a ratio buy-write strategy. The trader's goal is to earn premiums from the call options. The profit potential of variable ratio writing is limited. This strategy is best suited for stocks expected to have low volatility, especially in the short term.
Origin: The variable ratio writing strategy originated with the development of the options market, particularly after the establishment of options exchanges in the 1970s. As options trading became more popular, investors began exploring various strategies to maximize returns and manage risks. Variable ratio writing, as a complex options strategy, gradually gained adoption among professional traders and investors.
Categories and Characteristics: Variable ratio writing strategies can be classified based on the number of call options written and their strike prices. The main types include:
- Single Strike Price: In this strategy, the investor writes multiple call options with the same strike price. This method is simple but carries higher risk.
- Multiple Strike Prices: The investor writes multiple call options with different strike prices. This method can spread risk but requires more complex management.
- Generating income through premiums.
- Limited profit potential with higher risk.
- Suitable for markets with expected low volatility.
Case Studies:
- Case 1: Suppose an investor holds 100 shares of a company, currently priced at $50. The investor writes two call options with strike prices of $55 and $60. If the stock price does not exceed $55 at expiration, the investor will earn premiums from both options. If the stock price exceeds $55 but not $60, the investor will be required to sell the shares at $55 but retains the premium from the $60 option.
- Case 2: Another investor holds 200 shares of a tech company, currently priced at $100. The investor writes three call options with strike prices of $110, $120, and $130. If the stock price does not exceed $110 at expiration, the investor will earn premiums from all three options. If the stock price exceeds $110 but not $120, the investor will be required to sell some shares at $110 but retains the premiums from the other options.
Common Questions:
- Q: What is the main risk of the variable ratio writing strategy?
A: The main risk is significant price fluctuations in the underlying asset, which may force the investor to sell shares at a price lower than the market value, resulting in potential loss of gains. - Q: Is this strategy suitable for all investors?
A: No, it is not. The variable ratio writing strategy is complex and is more suitable for experienced investors or professional traders.
