Options traders like the ratio write. This is a strategy like the covered call, but when more calls are written than can be covered with stock. For example, if you own 300 shares of stock and you sell four calls, you have a 4:3 ratio write. Three calls are covered and one is not (or, you can describe this as a position that is 75% covered and 25% uncovered).

Amazon.com (AMZN) offers an example of when variable ratio writes work well to yield cash with manageable risks.

Bollinger Bands (solid lines represent upper and lower bands, dotted red line is middle band) sets up the effective trading range. Adding in the t-line (8-day exponential moving average, represented by the blue line) strongly defines a bullish channel. The upper Bollinger Band serves as rising resistance and the t-line as rising support. This is a strong bullish move complete with retracements, which add strength to the trend. Retracements identify profit-taking in the underlying and keep the trend moving nicely. But no trend continues forever. Given the recent rise from $760 per share up to $830, a consolidation or bearish reversal will occur at some point. At the moment of this status, however, a variable ratio write can yield a nice profit.

With Bollinger Band width at about 2100 points, picking strikes 50 points above current price sets up a comfortable buffer zone. For example, with 300 shares on hand, you set up a 4:3 variable ratio write with the following short calls:

Sell two 880 calls, bid 4.00 each, total 8.00. Adjust downward $10 for trading costs, net $790

Sell two 877.50 calls, bid 3.90 each, total 7.80. Adjust downward $10 for trading costs, net $770.

Total credit = $1,560

The attraction of the one-strike ratio write is the potential for higher premium income. Traders too often convince themselves that exercise is unlikely, and that time decay is probably going to outpace intrinsic value even if the calls go in the money.

Here’s the thinking: You open ATM or ITM positions with one to two months until expiration. It’s all time value, so that will evaporate very quickly. Even if the underlying price rises, you can close the exposed portion of the ratio and escape a net loss. Or you can roll the exposed positions forward.

The problem occurs when the underlying price rises so rapidly that you find yourself suddenly in a paper loss position. You have to either close the exposed calls at a loss or roll them forward.

When you roll, you receive more premium, but with this scenario it is likely that the one-to-one calls left are going to be exercised, meaning all of your underlying shares will be called away. Then you’re left with those rolled ITM calls. And they’re uncovered.

The solution is found in the variable ratio write. Use two strikes instead of one, and you set up a more effective buffer zone. In the example provides, you set up a 50-point buffer zone and create profits of $1,560 net, but exposure time is only 4 days (from the sample date of January 30). With expiration in only four days, time decay is going to be rapid, so profits will be realized quickly even if the underlying price moves up. With 50 points to go, this is easily managed – not foolproof, but likely to end up profitably.

If the underlying begins moving up and closer to the money, you can close some or all of the calls, probably at a profit, and avoid the unpleasant prospects of big losses due to uncovered exercise. You can also roll forward to avoid exercise in a worst-case scenario.

The variable expansion of the ratio write reduces risks significantly; but it does not eliminate them. You do have to be willing to live with the risk of sudden, significant movement in the underlying. And if you end up having to roll out of exercise danger, roll all of the calls to a later-expiring variable write. This at least defers exercise while generating more income. With extremely short-term expiration, you can wait for time decay to make your roll profitable. The risk is mitigated by timing the variable ratio writes for situations just like that of Amazon.com – a rapidly appreciating stock trending higher but likely to not take off suddenly, at least not in the next four days.