What it is
You buy one call, here at today's price, and sell two calls at a higher strike. The two sold calls pay for most or all of the bought one. The first sold call is covered by the bought call; the second is not, and that second call is what defines the trade's risk.
In this flat-volatility example it costs a small debit. Moving the sold strike closer to the price, or quotes with more premium above the money, can turn it into a credit, which removes the small loss on the downside.
What has to happen for it to make money
The stock has to rise toward the sold strike, but not far past it. The payout peaks exactly at the sold strike, where the bought call is worth the full gap and both sold calls expire. Above it, the uncovered call starts losing a dollar a share per dollar of rise, and past the upper break-even the position loses without limit.
Below the bought strike all three calls expire, so the result is just the opening debit or credit. It is a bet on a modest rise to a target, paid for by accepting risk on a large one. Falling volatility helps it before expiry, because it is net short an option.
Once it is on
A rally that approaches the sold strike is the good outcome and the point to decide: take the gain, or buy back one of the sold calls to remove the uncovered risk, which turns the trade into an ordinary call debit spread. Holding a ratio spread through a fast rally without a plan is how the second call does its damage.
What goes wrong
Too much of a good thing. The direction is right and the size is wrong: a stock that jumps well past the sold strike on news turns a winning position into one losing more with every dollar.
Margin. The uncovered call is margined like a naked call, and that requirement grows as the stock rises toward it, at exactly the moment the position is also starting to lose.
Pros and cons
- Pro: cheap, or even paid, to open.
- Pro: a large payout for a rise to the sold strike.
- Pro: little or nothing lost if the stock does not rise.
- Con: unlimited loss on a large rally.
- Con: the uncovered call needs margin.
- Con: rewards a target, not a direction.
In Restrike
The bought call and the two sold calls differ in size, so the Log leaves them as two rows rather than pairing them as a spread, and the Portfolio counts the sold calls against any shares you hold. A shared strategy label brings them together on the scorecards. Restrike imports them read-only from your broker and never places a trade.