How you should convert call spread into ratio spread
This strategy would help reduce losses, if not generate profits, on your initial position
Last week, we discussed how to reduce losses on a long call by converting the position to a bull call spread. But what if your initial position is a bull call spread? This week, we look at how converting a call spread to a ratio spread or to a lower strike call spread can help you reduce losses, if not generate profits, on your initial position.
Conversion ratio spread
Suppose you expect an underlying to find resistance at 14760. You set up a bull call spread by going long on a 14700 call and shorting the 14800 call on the same underlying for the same maturity. With the underlying currently trading at 14653, the spread can be set up for a net debit of 51 points (166 less 115).
How you should convert a long call to a bull spread
Useful when the underlying is likely to rebound soon after its drop
So far, we have discussed setting up option strategies. We now shift our discussion to managing these strategies. What should you do when your long call position accumulates losses as the underlying moves in the opposite direction? This week, we show how to recover unrealised losses on a long call by converting the position into a bull spread.
Conversion spread
Suppose you buy the 14400 call expecting the underlying to move from 14359 to 14750. Note that you will have to apply the “implied volatility” rule to choose between at-the-money (ATM), immediate in-the-money (ITM) and immediate out-of-the-money (OTM) options. This rule was explained in this column dated December 13, 2020.
Analysts are recommending the bull call spread to reduce the cost of the premium, as they do not want to take a directional trade given that the stock has already run up significantly. The outlook is bullish.