The Variable Ratio Write is a variant of the ratio write strategy in which the options trader owns a holding of the underlying stock and sells more calls than shares owned.
Hold 100 shares; Sell 1 call at the lower strike price; Sell 1 call at the higher strike price. Use the same expiration date.
Like the ratio write, it is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock price will experience little volatility in the near term.
Unlike the 2:1 Ratio Call Write, which involves writing two at-the-money calls, the 2:1 Variable Ratio Write involves writing one out-of-the-money call and one in-the-money call. As such, the Variable Ratio Write has a lower profit potential but the profit zone is wider.
Limited Profit Potential
Maximum gain for the Variable Ratio Write is limited and is made when the underlying stock price at expiration is anywhere between the strike prices of the options sold. At this price range, the higher striking short call expires worthless while the lower striking short call expires in the money.
Any loss resulting from the gain in the intrinsic value of the short call is offset by the premiums earned for selling this call while any profit from the drop in intrinsic value of this short call is completely negated by the corresponding depreciation of the long stock position. As a result, the options trader gets to keep as profit the time value of the premiums received when putting on the trade.
Lower strike price minus net opening cost.
Unlimited Risk Potential
Loss occurs for the Variable Ratio Write when the stock price makes a strong move to the upside or downside beyond the upper and lower breakeven points. There is no limit to the maximum possible loss.
Lower strike price minus net opening cost.
Breakeven Point(s)
There are 2 break-even points for the Variable Ratio Write position. The breakeven points can be calculated using the following formulae.
The breakeven can change depending on which strikes the stock finishes between.
Calculate the breakeven prices
- Net opening cost. Use this result only if it is at or below the lower strike price.
- Prices between the lower strike price and the higher strike price all break even only when the net opening cost equals lower strike price.
- Lower strike price plus higher strike price minus net opening cost. Use this result only if it is at or above the higher strike price.
Ignore results below zero. A boundary price listed twice is a single breakeven.
Referring to the graph shown above, since the maximum profit is $400, the maximum profit expressed in points is therefore equal to 4. Therefore, upper breakeven is at $54 while lower breakeven is at $36.
Example
Suppose XYZ stock is trading at $45 in June. An options trader executes a 2:1 Variable Ratio Write by buying 100 shares of XYZ stock for $4500, selling one in-the-money JUL 40 call for $700 and selling another out-of-the-money JUL 50 call for $200. The total premiums received for putting on the trade is $900.
On expiration in July, if XYZ stock is still trading at $45, the long stock position is still worth $4500, the JUL 50 call expires worthless while the JUL 40 call expires in the money with $500 in intrinsic value. With $900 in premiums earned, buying back the short JUL 40 call for $500 still results in a $400 profit. This is the maximum profit and can be made when XYZ stock price is anywhere between $40 and $50.
If XYZ stock rallies and is trading at $54 on expiration in July, all the call options will expire in the money. The JUL 40 call is now worth $1400 while the JUL 50 call is worth $400. This $1800 loss is completely offset by the $900 appreciation of his long stock position and the $900 in premiums he received earlier. Therefore, he achieves breakeven at $54.
Beyond $54 though, there will be no limit to the loss possible. For example, at $70, the written JUL 40 call will be worth $3000 while the JUL 50 call will be valued at $2000, resulting in a combined loss of $5000 on the short position. Meanwhile, his long stock position has only appreciated by $2500 and together with the $900 in premium received, the options trader still need to come up with another $1600 to close the position.
Using the formula for computing the breakeven point, we calculated the lower breakeven point to be $36. At $36, all the call options expire worthless. However, his long stock position also suffers a loss of $900 in value but this loss is offset by the $900 in premiums earned. Therefore, there is breakeven at $36.
Below $36 however, there is no limit to the potential loss. For example, if the stock price is trading at $20 on expiration, while all the call options expire worthless, the long stock position suffers a $2500 drop in value. Even with the $900 in premiums to offset the loss, the options trader still suffers a $1600 loss.
These examples use standard U.S. stock options with a 100-share contract size and matching expiration dates. Related structures can use ETF, index or futures options, but contract multipliers, exercise style, settlement and the underlying price range can differ. A stock’s zero price floor must not be assumed for every futures contract.
Commissions
For ease of understanding, these examples exclude commissions, fees and financing costs. Include all costs when comparing an actual position; there is no universal commission amount.
For active traders, transaction costs can consume a significant part of returns. Compare the full commission and fee schedule, exercise and assignment charges, and bid-ask spreads. The cost of entering and closing every leg matters.
Similar Strategies
The following strategies offer related market exposure. Compare their construction, cost, maximum loss and assignment obligations; a similar outlook does not mean identical risk.
Before expiration and assignment
The diagrams and worked outcomes describe expiration payoffs, not an option’s market price before expiration. Time decay, implied volatility, rates, dividends and bid-ask spreads affect early closing values. American-style short options can be assigned early; a protective long option is not automatically exercised when a short leg is assigned. Closing or exercising one leg can change the remaining position’s risk.
Payoff summary
Maximum loss: Unlimited as the stock price rises.
Net opening cost means everything paid to open the position, less everything received. Include the shares as well as the options. If opening the position brings in money overall, treat that cost as a negative amount.
Amounts are per share before fees. Multiply by the shares covered by the position; standard equity options usually cover 100 shares per contract. If a maximum profit or loss calculation gives a negative amount, use zero. These figures assume matching contracts held to expiration and do not include financing or early assignment.
