Consider a ratio spread comprising a call at strike $K _ { 1 }$ and short two calls at strike $K _ { 2 } K _ { 1 }$ . The current stock price is at $K _ { 1 }$ . The market view for this trade is most likely to be:
A) That the stock is more likely to fall in price than rise in price.
B) That volatility of the stock is likely to rise.
C) That the stock is likely to experience high levels of positive skewness in returns.
D) That the stock will rise but not by an indefinite amount.

Question

Consider a ratio spread comprising a call at strike $K _ { 1 }$ and short two calls at strike $K _ { 2 } > K _ { 1 }$ . The current stock price is at $K _ { 1 }$ . The market view for this trade is most likely to be:
A) That the stock is more likely to fall in price than rise in price.
B) That volatility of the stock is likely to rise.
C) That the stock is likely to experience high levels of positive skewness in returns.
D) That the stock will rise but not by an indefinite amount.

Quizplus · Accepted Answer

This strategy benefits if the stock price rises moderately. If the stock price rises too much, the losses on the short calls (at $K_2$) can outweigh the gains on the long call (at $K_1$). Therefore, it reflects a view that the stock will rise but not excessively.

Consider a Ratio Spread Comprising a Call at Strike K1K _ { 1 }K1​

Consider a Ratio Spread Comprising a Call at Strike $K _ { 1 }$