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Variable ratio writes are an investment strategy that involves the writing of two strikes using a fixed number of shares of an underlying security. In most examples of the variable ratio write, the underlying security will be at least a hundred shares. The basic idea for the variable ratio write is to hold a long position with the security while writing multiple option contracts at different strike prices.
The process involved with a variable ratio write is somewhat similar to that of ratio call writing in general. What distinguishes the approach is that a variable ratio write will involve two options written for the block of one hundred shares of the underlier. The type of calls can vary with this approach, since the variable ratio write may be accomplished with both in the money and out of the money calls.
One common approach to a variable ratio write is to employ what is sometimes referred to as a two to one strategy. This involves being long in the hundred shares and writing two different calls at different strike prices. One call will in the money, with the second being written as a out of the money call. This approach is understood to provide greater chances of a return for the trader, since a broader range of prospective moves on the security is accounted for with the different types of calls.
Employing the use of a variable ratio write should be approached with planning and precision. Generally, it is not a good idea to use a variable ratio write unless the trader is reasonably sure that the underlying security possesses no more than a limited amount of volatility. The stability of the underlier is crucial to the success of this type of options strategy, as unanticipated shifts in the value of the underlying security will throw the appeal of the strike prices out of line. For this reason, financial advisors tend to counsel clients to approach the idea of a variable ratio write only when all feasible market conditions and their impact on the security have been taken into consideration.
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