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4may - tonights Options Action web extra features one of my favorite options trades, the Ratio Spread, sometimes called a Backspread. sometimes a "trade repair", sometimes "CPR", see video here web extra . what i call this sometimes is "a free trade"
scott is doing a 1x2 Call spread:
Buy one of the Aug 29 calls at $2.65
Sell two of the Aug 32 calls at $1.40 each
credit of $.15 per 1x2
scott correctly mentioned that this should be done being already long stock. so breaking it down, say you own 100 shares with stock at 28ish.. you are buying one call (29) and selling two higher strike calls (32).. what this is , is a stock with covered call and an additional 29/32 call spread. so you will not need any additional margin/buying power to put this on. The max profit of this trade is a pin at 32 at Aug opex. Just the ratio portion of the trade profits from 29-35. but you also profit on your stock as it moves up as well, so a ratio spread gives you double upside with no added risk. scott says you can get "called away" at essentially at 35..true, or you can just close out this ratio spread instead of just starring at your screen on opex day.
Better than this is doing a ratio spread on top of a long option instead of the stock, say a Deep-in-the-money LEAP option, say the jan2013 20 strike call option.. 100 shares of stock is $2800 cash, but one Jan2013 20 strike is about $925.. one third the cost needed... add this same ratio spread and your broker just looks at it just like a covered call... the jan2013 call matches up with an Aug 32 short call which makes it a diagonal spread and then you have a regular call spread with the remainder (29/32).. again, no added margin needed.. so you can still get that double upside but now only commit $925 instead of $2800
But check this out, if you had $2800 to commit to this, instead of buying 100 shares...buy THREE of those Jan2013 20 calls for about $2800...now you can do a 3 lot of the ratio spread (buy 3 aug 29's / sell 6 aug 32's). Using the trademonster analyse tab, if stock pins at 32 on Aug opex with this $2800 investment into 3 calls, your profit is $1700...about 55%+ gain vs a $680 gain on owning stock and doing one ratio spread. Greater leverage.
Using Ratio spreads does not preclude you from still adding an additional hedge for downside..such as put spread, just gives you greater leverage to upside
Historically the issues ive had using ratios is that i did not go high enough in strikes..that the stock moved more than i expected.. so you might have to pay a little bit to get a wider spread to get that max gain...ie, this ratio does not help you if stock pops to 45 at Aug opex, you pretty much cap your gain at 35. so just staying with this example and not looking at the prices...would look at a 30/35 ratio spread for small debit... you can even get cute and just buy one 30 call , sell one 35 call and try to leg into that 2nd 35strike call if stock goes up to get a better price (and possibly make ratio zero cost).. Kudos to scott to pulling out a goodie but underused Ratio Spread. Downside is that you will not get that max profit till almost opex even if stock pops right away, have to plan on holding all the way.
