Is Call Ratio Spread suitable strategy for an options newbie?

Discussion in 'Options' started by thkang, Jun 13, 2011.

  1. thkang

    thkang

    Hi, this is my first post on the ET forum and I'm shamelessly asking a question :D

    As a starter I'd like to have absolute profit and avoid as much risk as possible. The strategy that caught my eyes is Call Ratio Spread.

    Lets say a trading vehicle is priced around 31~32; than assuming it's not an explosive bull market(also IV are reasonable and so are bid/ask spread and broker commissions) I can buy some ITM calls(say, 30)( and sell more OTM calls(say, 35), entering in a net credit.

    That would give me an delta neutral position and My profits would be assured If the underlying price is below OTM call's strike price(35). maybe I can exit the position when it reaches 34 or so. My 30 Calls will be exercised or sold for profit. OTM calls will be bought back(since they're OTM, which means their intrinsic value is zero and because of the time decay I'd benefit from closing this session)

    Is there something wrong with my trade? I did it in paper trading a few times. I do know that my risk is virtually unlimited but you can set the limits before entering.

    Dont hesitate to correct me if I'm delusional and Thanks for reading!
     
  2. MTE

    MTE

    Setting a limit (stop) works fine until it doesn't. What are you gonna do when the underlying gaps up? If you are a newbie, I suggest you stay away from unlimited risk strategies for the time being.
     
  3. if implied volatily soars, you will be in deep red.
    it is also difficult to stay delta neutral with this strategy. When UL moves, you will deviate from the non-zero delta, how will you go to deltra neutral again (or will you?)
     
  4. rmorse

    rmorse ET Sponsor

    "My profits would be assured" is an interesting way to put it. I think ratio spreads are good strategies to look at, but there is risk on the upside that you have to be comfortable with. Better to do these types of spreads in a Portfolio margin account. I like to do these types of spreads when I'm a little bearish. If the spread is a credit, you make money if the stock goes down. If the stock does not shoot up, you'll make money. I don't like ratio put spreads as much. When stocks go do the vol can explode, and drive through the price. Not good.
     
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  6. Your safe exit idea only works at/near expiration when time decay has worked its magic on the short calls and the UL has appreciated toward 35.

    If your underlying heads upward immediately, your position will incur losses right out of the gate. If it continues up, rising past your short strike, you will never have an opportunity to breakeven. To add insult to injury, if IV expands, it'll will only get worse.

    As MTE suggested, avoid naked strategies until you fully understand them and I'd add, you have the discipline to deal with them. The last thing you want to be is the deer in the headlights :)
     
  7. Call Ratio Spread is not a suitable strategy for options newbies.
    I agree with what everyone said above.
    It's not guaranteed that you'll stay delta neutral and if the market moves against your trade, how will you go back to being delta neutral?
     
  8. You are getting good advice.

    On top of everything, they have written, you will find there are onerous margin requirements because of the risk you are taking with writing naked calls.

    If you want to do a ratio spread like position, try a broken wing butterfly/ unbalanced butterfly ( or a combination of the two) which is a little similar but not nearly as risky..

    As an example of what I mean,

    If you are pessimistic to slightly bullish on AAPL for example, you could do this-- and this is an example and not a recommendation--

    buy 1 July 325 call current price= 9.95
    sell 3 July 335 calls current price = 5.20
    buy 2 July 350 calls current price = 1.64

    net credit= (-9.95-2*1.64+3*5.2)=2.37

    This limits your losses to a maximum of $2000.00, while giving you an opportunity to make close to $1237.00 if AAPL approaches 335 just before the July expiry. If AAPL declines, you still keep the $237.00 credit which is still a decent return on margin.

    You can easily tweak your risk by using the 345 calls instead for a smaller net credit and much less risk or buy an extra 350 call which could pay off nicely in a sharp upward move, as well.
     
  9. thkang

    thkang

    thanks for all the advices. after some pondering I found my strategy is some mutated form of selling naked calls, that i saied hell no when I first saw its risk/reward graph.

    I'm more comfortable with buying options than selling them since I'm kinda null on the topic of how IVs would fluctuate - All I know is than in long term they would converge to UL' HV (and not always)
     
  10. ajna

    ajna

    Along the lines of a broken wing butterfly, buy your long wing really far out of the money with extra wings. You can still trade your primary position as a call ratiospread, but still have the additional protection in case things go bad.
     
    #10     Jun 14, 2011