Ratio Call Spreads Bootcamp Video (BigPicture Trading) Member Content – Options trading
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Expert level video for trading options ration call spreads. Member content.
A ratio call spread is an options trading strategy that involves buying a certain number of call options at one strike price and selling a larger number of call options at a higher strike price. This strategy is typically used by traders who have a neutral to slightly bullish outlook on the underlying asset and want to profit from a limited rise in its price while minimizing costs.
### Key Features of a Ratio Call Spread
1. **Bullish Outlook**:
– The strategy benefits from a moderate rise in the price of the underlying asset. If the asset’s price increases significantly beyond the higher strike price, the strategy can result in substantial losses.
2. **Limited Profit Potential**:
– The maximum profit is achieved when the underlying asset’s price is at the higher strike price at expiration. Profits are limited to the difference between the two strike prices minus the initial net debit or credit.
3. **Potential for Net Credit**:
– Depending on the strike prices and the premiums of the options involved, the strategy can be established for a net debit (cost) or a net credit (income). If established for a net credit, the trader receives an upfront premium.
4. **Unlimited Loss Risk Beyond Breakeven Point**:
– If the price of the underlying asset rises significantly beyond the higher strike price, the short call options can lead to unlimited losses.
### Construction of a Ratio Call Spread
1. **Buy Calls**: Purchase a certain number of call options at a lower strike price.
2. **Sell Calls**: Sell a larger number of call options at a higher strike price.
For example, a 1:2 ratio call spread involves buying one call option at a lower strike price and selling two call options at a higher strike price.
### Example of a Ratio Call Spread
#### Assumptions:
– Current price of the underlying asset: $50
– Buy 1 call option with a strike price of $50, premium = $3
– Sell 2 call options with a strike price of $55, premium = $1.50 each
#### Strategy Setup:
– **Buy 1 Call**: $50 strike price, premium = $3
– **Sell 2 Calls**: $55 strike price, premiums = $1.50 each
#### Net Cost (or Credit):
– **Cost of Buying 1 Call**: $3
– **Premium from Selling 2 Calls**: $3 ($1.50 each)
In this example, the initial net cost is $0, making it a zero-cost spread.
### Profit and Loss Potential
1. **Maximum Profit**: The maximum profit is realized if the price of the underlying asset is at the higher strike price ($55) at expiration.
– **Calculation**: Difference between strike prices – net cost
– **Example**: ($55 – $50) – $0 = $5 per share
2. **Breakeven Points**:
– **Lower Breakeven**: Strike price of the long call + net debit (if any)
– **Upper Breakeven**: Strike price of the short calls + (difference in strike prices / number of short calls – 1)
– **Example**: If there was a net debit of $1, the lower breakeven would be $51. The upper breakeven would be calculated by considering the additional gain from the premium received.
3. **Potential Loss**:
– Loss is unlimited beyond the upper breakeven point because the trader is short more call options than they are long, leading to significant losses if the underlying asset’s price rises sharply.
### Summary
– **Ratio Call Spread**: An options strategy involving buying and selling calls at different strike prices in unequal quantities.
– **Usage**: Suitable for traders with a neutral to slightly bullish outlook.
– **Profit Potential**: Limited to the difference in strike prices minus net cost.
– **Risk**: Unlimited if the underlying asset’s price rises significantly beyond the upper breakeven point.
– **Initial Setup**: Can be established for a net debit or net credit depending on the premiums involved.
This strategy requires careful risk management and monitoring due to the potential for significant losses if the underlying asset’s price moves unfavorably.
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