Covered Call Ratio Spread Strategy

The Covered Call Ratio Spread is an enhanced version of the traditional covered call. It involves owning stock and selling multiple call options while buying a higher-strike call to hedge excess exposure. This strategy aims to generate additional income while maintaining partial upside protection. It’s best suited for traders with a moderately bullish outlook who are comfortable with assignment and margin risks.

Structure

• Own 100 shares of the underlying stock
• Sell 2 ATM or OTM Calls (Strike B)
• Buy 1 OTM Call (Strike C > B)
• All options share the same expiration date

Profit & Loss Profile

• Max Profit: Occurs if the stock closes at Strike B—both short calls expire worthless and the long call retains value
• Max Loss: Substantial if the stock drops sharply—losses from long stock position offset only by net premium
• Breakeven: Stock purchase price minus net premium received
• Greeks: Delta-positive, Theta-positive (premium decay), Vega-negative (short volatility exposure)

Example

You own 100 shares of XYZ at $50. You:

• Sell 2 x $55 Calls for $2.00 each
• Buy 1 x $60 Call for $1.50

Net credit = $2.50. If XYZ closes at $55, both short calls expire worthless and the long call may retain some value. If XYZ rises above $60, the uncovered short call becomes a liability, offset partially by the long call.

Ideal Market Conditions

• Outlook: Slightly bullish
• Volatility: Elevated IV improves premium income; falling IV post-entry is favorable
• Time Horizon: Short- to medium-term
• Goal: Generate income with partial upside hedge

Risk Considerations

• Uncovered short call risk if stock rallies past Strike C
• Requires margin for uncovered call exposure
• Early assignment risk on short calls
• Complex payoff structure—use risk graphs to model outcomes
• Not suitable for volatile or strongly bullish markets

Summary

The Covered Call Ratio Spread offers enhanced income potential over a standard covered call, with partial protection against upside risk. It’s ideal for traders who expect modest stock appreciation and want to monetize time decay while managing assignment risk. Proper sizing and monitoring are key to avoiding margin surprises.