CASE STUDY: Citi Oct 27 – 30 Call Ratio Spread — *exercise/assignment*

| August 2, 2012 | 0 Comments More

Citi (C) loses 70 cents to $26.07 and an Oct 27 – 30 (1X2) call ratio spread trades on the bank today for 46 cents, 4000X, to open. Citi is sliding today, but has been rangebound for more than two months and is at the same levels today as late-May. In fact, the stock is at the same levels as late-August of last year. The 1X2 seems to express the view that the stock could trade back towards $30 through mid-October. The 2012 high is just north of $38 and dates back to late-March. I like this idea and so let’s open it today for a Case Study for a 1X2 Call Ratio Spread. (Note that the Facebook Put Spread was closed today).

A call ratio spread is the right strategy when the investor expects the underlying to trade northward, but doesn’t expect a dramatic move higher or an extreme spike. Ratios can vary, but 1X2s and 2X3s are the most common. In a 1X2 call ratio spread, the investor is buying calls at one strike and selling twice as many calls at a higher strike. Selling 2X as many upside calls lowers the costs of buying the downside call and also reduces the risk of time decay. 1X2 call ratio spreads are often initiated for very small debits and sometimes even a credit.
The max profits from a call ratio spread happen if shares move to the higher strike of the spread through the expiration. At that point, the lower strike calls have increased in value and the other leg of the spread expires worthless. If shares hold below the lower strike, the entire debit is at risk. The breakeven is equal to the lower strike plus the debit. The more significant risk, however, is from a dramatic move to the upside because of the additional short call position. In a 1X2, the upside breakeven is equal to the higher strike plus the difference in strikes minus the debit. When dealing with other ratios, the upside breakeven can be a bit more complicated to compute. Creating a payoff chart makes sense in those situations.

In this case, shares are trading for 26.72 and Citi Oct 27 – 30 (1X2) call ratio spread traded for0.46. The risk to the trade is the debit paid, or 0.46 if shares hold below the lower strike or 1.05 percent from current levels. One breakeven is equal to the lower strike price plus the net debit, or 27.46 and 2.8 percent from current levels. There is additional risk to the upside due to the short call position and the next breakeven is at 32.54 or 21.8 percent from the current price. The max profits happen if shares rally to the higher strike and equal the diff in the strike prices minus the debit, or 2.54. The OptionsXpress payoff chart shows the risk-rewards and probabilities of success graphically.

Case Study – C Oct 27 – 30 (1X2) call ratio spread
Bias = Bullish
Risk = Debit=0.46
Reward = Diff in strikes – debit =2.54
Breakeven=lower strike-debit=27.46
Breakeven=Diff between strikes + higher strike – debit=32.54

Download PDF—> CitiOct2730callratiospread

Way too much of a good thing on this one. Stock was at $37.34 at the Oct expiration, resulting on exercise and assignment on all legs of the spread. Cover at a loss (11/2)


Category: All Stocks, Banks, Large Cap Stocks, Trading Education

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Frederic Ruffy is a well-known trader, writer, and strategist who has spent years educating investors and creating intelligent, insightful, unbiased market observations that are frequently cited by the Wall Street Journal and other financial publications. As senior analyst, Fred provides frequent and regular notes and daily updates for activity of interest.