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Track 'n Trade Futures End of Day Options

Call Ratio Spreads

Video Transcript

In this Track 'n Trade Pro Options trading training video, I want to talk to you about Call Ratio Spreads. When a market makes a relatively quick big upmove, the general public rushes in and buys out of the money Call Options. This causes those Options to be over-priced in relationship to the at the money Options. This is another nice strategy that often provides a wide profit zone.

Here's how you can take advantage of the situation:

Look at price charts, and find a market that has just made a very fast upmove and is now slowing down, or even topping out. This often happens when there's a weather scare, which affects markets, such as soybeans, coffee, cocoa, etc.. But it can occur in almost any market. Once you find a market, in this situation, look at the Options for the given underlying commodity. If you notice that out of the money Call Options have a significantly higher implied volatility than Call Options, which are closer to the money. Of course, your broker can help you with this, as well. You can capitalize on the discrepancy by setting up a Call Ratio Spread, just like this.

First: Buy one or more Options at the same time. Sell a larger number of Options further out of the money. So, for example, you may buy one Call Option at the money, and sell two Call Options, out of the money. Which you have identified as being over-priced.

Another variation, is to buy 1 Call Option, out of the money, and sell two Call Options, that are further out of the money. You can also use a different ratio, other than one to two. For instance: You may buy two Options at the money, and sell three Options out of the money. You normally want to do this trade, only if you receive a credit. This will give you a very large profit zone, that stretches from zero, all the way up to a price which exceeds your upper strike price.

This call ratio strategy has a couple distinct advantages. One: if you do it for a Net Credit, your profit zone can be quite wide. This gives you a high probability of making a profit. The potential profit can also be quite large. But it also has a potential problem, to watch out for. If the price of the underlying commodity rises, up to the strike price, the Options you sold, they will go in the money. At that point, you should consider closing out the position, just to play it safe.


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