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Friday September 03, 2010 |
Advanced Strategies for Options -
Horizontal Spreads - Ratio Calendar Spread
In
previous lessons we have written about the ratio and calendar
spreads. As you might
expect the ratio calendar spread is merely a combination of these
two strategies. In
the calendar spread the investor buys a longer term option and
sells a near term option with the same strike price
In the ratio calendar spread this strategy is duplicated
with one small exception, the investor sells a number of near term
calls while buying fewer of the longer-term calls.
Since more calls are being sold than our being bought this
strategy involves naked options and thus there will be a margin
requirement.
In
many cases ratio calendar spreads can be set up for a net credit.
This means all things being equal the position will return
a profit. However,
because naked options are involved there will be a margin
requirement and depending on the number of near term calls that
are sold this requirement could be large.
The
obvious advantage of any ratio spread is that if the near term
call expires worthless the longer-term call is essentially owned
for free. This means
regardless of what happens to the underlying common stock, the
spread cannot lose money. Indeed
if the underlying common stock advances substantially significant
profits will accrue.
The
collateral requirement for a ratio spread is equal to the amount
of collateral required for naked calls less the credit taken in
for the spread.
Consider
the following example. Mario
is an avid golfer and he has been watching Callaway Golf (ELY)
shares for many months. He
knows that the firm will be unveiling a new line of irons at the
April Golf World show. Because
he believes the stock is unlikely to rally substantial ahead of
this show he decides to establish a ratio calendar spread to take
advantage. With ELY
shares trading at $12, Mario buys one contract of the June 15 call
at $2 per contract or $200 and sells two contracts of the April 15
calls at $1.25 or $250. These
transactions create a net credit of $50. For the purposes of this
example we will assume that the April calls expire worthless.
Let’s take a closer look.
|
ELY
Share Price at Expiration
|
April
15 call price
|
Profit
for 2 April 15 calls
|
June
15 call price
|
Profit
for June 15 call
|
Total
Profit
|
|
8
|
$0
|
$250
|
$0
|
($200)
|
$50
|
|
10
|
$0
|
$250
|
$0
|
($200)
|
$50
|
|
12
|
$0
|
$250
|
$0
|
($200)
|
$50
|
|
14
|
$0
|
$250
|
$0
|
($200)
|
$50
|
|
15
|
$0
|
$250
|
$0
|
($200)
|
$50
|
|
17
|
$0
|
$250
|
$2
|
$0
|
$250
|
|
19
|
$0
|
$250
|
$4
|
$200
|
$450
|
|
21
|
$0
|
$250
|
$6
|
$400
|
$650
|
As
we can see from the example above Mario’s ratio calendar spread
offers excellent profit potential if the April calls expire
worthless. Mario essentially gets the June 15 call for free and profits
accelerate tremendously once the stock trades above the $15 strike
price.
Summary
1.
Chose a stock that is sufficiently volatile to move
above the strike price in the allotted time.
2.
Do not use calls that are so far out-of-the money
that it will be virtually impossible for the stock to reach the
strike price.
3.
Always set up the spread for a credit, commissions
included.
4.
Determine break-even points before the spread is
established.
5.
If the underlying common stock rallies
substantially before the near month expiration date the position
should be closed.
6.
Ratio calendar spreads offer a large probability of
profit and losses should be relatively small if defensive action
is taken if the stock advances quickly ahead of the near term
expiration.
|
Situation
|
Outcome
|
Probability
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|
Stock
does not rally above strike
|
Small
profit
|
Large
probability
|
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Stock
rallies above strike in a short time frame
|
Small
loss if defensive action is deployed
|
Small
probability
|
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Stock
rallies above strike price after near term call expires
|
Large
potential profit
|
Small
probability
|
delta neutral calendar spread
diagonal
bull spread
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Home > Education > Using Options > Advanced Strategies >
Horizontal Spreads > Ratio
Calendar Spread
