Ratio Call Spread: Generating Income with Embedded Uncovered Risk
An investor executes a 2-for-1 ratio call spread by buying 1 XYZ 50 Call for $5.00 and writing 2 XYZ 60 Calls for $2.50 each when XYZ trades at $48. If XYZ stock surges to $95 at expiration, what is the financial result for the investor?
Writing more calls than purchased (e.g. 2-for-1) leaves the extra short calls UNCOVERED. If the stock skyrockets to $95, the unlimited liability on the naked call produces massive losses.
Complete Analysis & Legal Rationale
In a 2-for-1 ratio call spread, the purchased 50 call covers one of the written 60 calls. However, the second written 60 call is completely uncovered (naked). If XYZ surges to $95: Long 50 Call is worth +$45. Short 60 Call #1 loses -$35. Short 60 Call #2 (naked) loses -$35. Net result: +$45 - $35 - $35 = -$25 per share ($2,500 net loss). The position has unlimited upside risk.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Writing more calls than purchased (e.g. 2-for-1) leaves the extra short calls UNCOVERED. If the stock skyrockets to $95, the unlimited liability on the naked call produces massive losses.
Fails to reflect correct options pricing/mechanics for B.
Fails to reflect correct options pricing/mechanics for C.
Fails to reflect correct options pricing/mechanics for D.
Official Standard: In a 2-for-1 ratio call spread, the purchased 50 call covers one of the written 60 calls. However, the second written 60 call is completely uncovered