Variable Ratio Write Definition

What is Variable Ratio Write?

A Variable Ratio Write is an advanced call option strategy where you own 100 shares of an underlying stock and sell two call options with differing strike prices. This approach generates income by collecting premiums from multiple calls while maintaining some upside potential on your shares.

It builds on the covered call strategy but uses a variable ratio of calls written, balancing premium income against the risk of assignment and price movements.

Key Characteristics

This strategy combines stock ownership with option selling to enhance yield and manage risk:

• Position setup: Own 100 shares and write one call option near the current stock price plus another call option at a higher strike price, creating a variable ratio position.
• Income generation: Collect premiums upfront from both calls, increasing potential income compared to a standard 1:1 covered call.
• Risk profile: Exposure to assignment risk on one or both calls, with capped upside if stock price rises above the higher strike.
• Premium trade-off: Higher income but greater chance of losing shares due to potential naked call risk if not properly hedged.
• Market outlook: Best suited for a neutral to slightly bullish view on the underlying stock.

How It Works

You start by holding 100 shares of a stock and then write two call options with different strike prices—one closer to the current price and one further out-of-the-money. This variable ratio allows you to collect two premiums, enhancing your income compared to a traditional covered call.

At expiration, if the stock price remains below the lower strike, you keep the premiums and shares; if it rises between strikes, one call may be exercised, and if it exceeds the higher strike, both calls are exercised, capping your gains. Managing the risk of early exercise and understanding your maximum profit and loss scenarios are crucial to success.

Examples and Use Cases

Variable Ratio Writes are popular among investors seeking income enhancement without fully exiting their stock positions. Examples include:

• Airlines: Investors holding shares of Delta might write calls at different strikes to generate yield amid volatile travel demand.
• Dividend stocks: Combining this strategy with holdings in high-yield companies can complement income from dividends; explore top picks in our best dividend stocks guide.
• Cost-conscious investors: Those using commission-free brokers can implement this strategy with lower trading costs, improving net returns.

Important Considerations

While Variable Ratio Writes can enhance income, they carry risks like potential share assignment and limited upside if the stock surges. Understanding tail risks and monitoring option expiration dates is essential.

This strategy requires options approval and a firm grasp of option mechanics to avoid unintended losses or early assignment. Always evaluate your market outlook and risk tolerance before implementing this approach.