The ratio calendar combination spread couples two ratio calendar spreads, one using calls and the other using puts. The call strike prices are higher than the put strike prices. This strategy is complex and profit is limited, but if a high amount of time value is involved in the short positions, that profit can be substantial and risk is still limited.
The underlying stock is valued at $108.10. You initiate a ratio calendar combination spread with the following positions expiring in the months of April and May:
Sell April 105 put at the bid $1.70
Sell April 110 call at the bid $2.15
Credit 1.70 + 2.15 = 3.85
Buy May 105 put at the ask $2.95
Buy May 110 call at the ask $3.63
Debit -2.95 + -3.63 = -$6.58
Total net debit 3.85 – 6.58 = -2.73
The advantage to this combination is maximized when the underlying stock price remains in the middle range until the earlier short April option expirations, and then the stock moves above or below that middle range. In this way, the short positions expire worthless or at a profit, leaving the potential for profits from the longer-term long positions.
If the underlying stock expires between $102 (lower breakeven price) and $113 (upper breakeven price), then the short April options will be profitable; if the underlying stock settles at or above $117 or at or below $97, then the long options will be profitable.
In “Combo spread scorecard,” we list out the profit or loss for both the April and May combinations.
This strategy has the benefit of collecting premium on the front or being in a profitable long position with defined risk.
This column features strategies that are included in more detail in Michael Thomsett’s upcoming book “The Complete Options Trader.”