FxWirePro: Short side of USD/JPY call ratio spread – a run through

If you understand that any call option gives the holder the right, but not the obligation, to buy USDJPY at a predetermined price on a certain date, it's time to think about the other side of that transaction. In order for someone to buy the call option, someone has to have sold the right to that person. The person buying the call option hopes the price of the underlying asset will go up, and the person who sold that person that right is hoping the price will continue to remain the same or slip down and such is the case with USD/JPY.

In our opinion, it would certainly not be sharp spikes for this pair for sure until Fed's meeting, so keeping this in mind, at the money or out of the money call shorting is recommended as a speculation basis. Thereby, high premiums on call shorting can be certainly locked in as our return. The main objective of writing naked calls is to collect the premiums when the options expire worthless.

Why call ratio spread: As the pair has made steep slumps and healthy recovery we see a neutral to bearish environment when you are projecting decreasing volatility (see from next 1 month to 3 month it's been gradually reducing) and the pair to remain either range bound or slightly weaker, when you are looking to generate income.

How to execute: Current USDJPY FX spot is trading at 121.079. Buy one next month ITM (116.127) 0.5 delta call. Sell two lots of OTM strike calls (124.275). The delta value becomes more and more insensitive as the USD/JPY falls lower and lower and hence on the lower side, the delta value is zero. On the higher side, it increases in magnitude but remains negative indicating the negative effect on the option trader position with the pair rallying.

Advantage: If you guessed correctly and the pair remains range bound, net credit earned.

Risk/Reward Profile: The risk is unlimited. The reward is the difference in the strike prices plus the net credit, multiplied by the number of long contracts.