What is Variable Ratio Write?

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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 write is an options investment strategy that involves holding an 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 write strategy originated with the development of the options market, particularly during the late 20th century as options trading became more popular. As investors sought additional income through options, this strategy was gradually developed and applied.

Categories and Features

Variable ratio write strategies can be categorized based on the choice of strike prices and the number of options written. Features include reducing holding costs by collecting premiums, but also limiting potential upside gains. It is suitable for low volatility market environments.

Case Studies

Case 1: An investor holds 100 shares of XYZ company and writes two call options with strike prices of $50 and $55. If the stock price is below $50 at expiration, the investor retains the premiums. Case 2: Another investor holds 200 shares of ABC company and writes three call options with strike prices of $60, $65, and $70. If the stock price is above $70 at expiration, the investor must sell the stock at $70 but retains the premiums.

Common Issues

Common issues for investors include how to select appropriate strike prices and the number of options, as well as managing potential risks. Misconceptions include believing this strategy can profit in any market condition, whereas it may lead to losses in high volatility markets.

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