Options-Buying stock with Ratio Call Spread!!

Welcome to Buying Stock with Ratio Call Spread, where you will be taught:

The mechanics of the Buy Stock with a Ratio Call Spread strategy

Risk and reward potentials
When to implement ratio call spreads alongside long stock positions
How a stock repair strategy works
When to implement a stock repair strategy

Buy Stock with Ratio Call Spread: Defined
This strategy involves buying stock and, at the same time, buying an at-the-money call for each 100 shares purchased and simultaneously selling an equal number of out-of-the-money calls.

Example 1: Buy 100 shares of stock at 50,buy an April 50 call, and, sell 2 April 55 calls.
Example 2: Buy 200 shares of stock at 75,buy 2 June 75 calls, and sell 4 June 85 calls.

There are no uncovered short calls. One short call is covered by long stock; the other is covered by the long call. (i.e. a bullish vertical call spread).
This is a stock-oriented strategy and does not involve leverage if the stock price declines.Losses from price decline equal to owning stock only if done at zero cost - if ratio spread done for a credit, the stock loss is reduced by amount of credit and, if done for a debit, the stock loss is increased by amount of debit.
Leverage is involved when the stock price rises.
This strategy has a limited profit potential.

Buy Stock with Ratio Call Spread Profit/Loss Diagram
Notice that greater leverage is involved when the stock rises, and is represented by a steeper line.
The horizontal line represents the limited profit potential of this strategy.

Mechanics at Expiration
For the Buy Stock with Ratio Call Spread strategy there are three possible outcomes. The stock price might be any of the following:

1. At or below the lower strike: Long stock
2. Between the strikes: Long stock & Long call
3. Above the upperstrike: No position

Below the Lower Strike: Long Stock
Given the following example with zero cash outlay:

Buy XYZ Stock @ 50
Buy 1 XYZ March 50 call @ 3
Sell 2 XYZ March 55 calls @ (1.50)

If the stock price is at or below $50 at expiration, all options expire worthless. The amount of the loss depends entirely on the long stock position. Therefore, at expiration, this strategy will lose $1 per share for each $1 that the stock price is below $50.

Between the Strikes: Long Stock & Long Call

Observe the following example:

Buy XYZ Stock @ 100
Buy 1 XYZ March 100 call @ 6
Sell 2 XYZ March 110 calls @ (3)

Given a stock price above 100 and below 110, the profit is twice what the stock profit profit would be with only 100 shares.

Above the upper strike: No Position

Observe the following example:

Buy XYZ Stock @ 50
Buy 1 XYZ March 50 call @ 3
Sell 2 XYZ March 55 calls @ (1.50)

If the stock price is above 55 on expiration day, the 50 call will be exercised and the 55 calls will be assigned. All 200 shares will be sold upon assignment. There is a possibility of early assignment on the 55 calls which may result in an obligation to pay a dividend.

Trade-offs for This Strategy

Some of the disadvantages to this type of strategy vs. buying additional shares of stock are:
Limited upside potential while a long stock position gives unlimited profit potential
Commission costs for options
Stock holder may have voting rights and receive cash dividends.

Another Application - The Stock Repair
Consider a scenario when you forecasted XYZ stock to move from $50 to $60 a share. However, instead of going up as you predicted, the stock lost $10 a share and is now trading at $40 a share. At this point you can take a loss if you have changed your mind about the stock or, at $40 a share, you are even more optimistic and may want to "double up."

Doubling Up: Disadvantages
Buying an additional 100 shares when the stock is down is known as "dollar cost averaging" or in laymen's terms "doubling up." The two disadvantages to this tactic are as follows:
1. Additional capital investment
2. The risk is doubled

Instead of automatically buying more stock, an investor could consider the ratio call spread for stock repair.

The advantages that the Buy Stock with Ratio Call Spread strategy has compared to simply buying an additional 100 shares of stock are as follows:
1. A lower breakeven price is achieved
2. No additional capital investment is required
3. The risk is not doubled if the stock price declines
4. Lower downside risk by using options

Summary - Buy Stock Ratio Call Spread
The Buy Stock with Ratio Call Spread is a prime example of how options give the investor a different set of trade-offs. Even if your forecast does not match this particular strategy's characteristics, you still gain understanding about controlling risk while increasing leverage.

Statistical and percentage based thinking in financial planning establishes the foundation needed to analyze a multitude of markets in order to meet your specific investment goals.