What is a Ratio Call Write?
A Ratio Call Write involves owning stock and selling more call options than shares owned. This strategy generates extra income from selling calls, but it exposes you to significant risk if the stock price rises sharply. Here’s how it works:
- You own 100 shares of stock, purchased at $100 each (total cost = $10,000).
- You sell 2 call options (which cover 200 shares) at a higher strike price (e.g., $110).
- You receive a premium of $600 (2 contracts at $3 per share, for 100 shares per contract).
How Payoff Works:
If the stock price stays below the strike price, you keep the net credit from selling the calls. However, if the stock rises significantly, the two sold call options will result in large losses since you only own 100 shares, but sold options for 200 shares.
Example Payoff Scenarios:
- Stock Price = $90:
- Stock Value: 100 shares at $90 = $9,000
- Calls expire worthless, and you keep the premium of $600.
- Total Payoff: $9,000 (stock) + $600 (premium) = $9,600
- Initial investment: $10,000
- Net payoff: $9,600 - $10,000 = -$400 (loss)
- Stock Price = $110:
- Stock Value: 100 shares at $110 = $11,000
- Calls expire worthless, and you keep the premium of $600.
- Total Payoff: $11,000 (stock) + $600 (premium) = $11,600
- Initial investment: $10,000
- Net payoff: $11,600 - $10,000 = $1,600 (profit)
- Stock Price = $130:
- Stock Value: 100 shares at $110 (due to the strike price) = $11,000
- You must buy 100 shares at $130 to fulfill the second call option, resulting in a loss of 100 shares × ($130 - $110) = $2,000.
- Total Payoff: $11,000 (from selling owned 100 shares) - $2,000 (loss from fulfilling call options) + $600 (premium) = $9,600
- Initial investment: $10,000
- Net payoff: $9,600 - $10,000 = -$400 (loss)