Put Ratio Backspread
put ratio backspread
 Details
 Category: nonsynthetic futures and option strategies
 Published on Wednesday, 17 February 2010 22:35
put ratio backspread
the put backspread (reverse put ratio spread) is a bearish strategy in options trading that involves selling a number of put options and buying more put options of the same underlying stock and expiration date at a lower strike price. it is an unlimited profit, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience significant downside movement in the near term.
put backspread construction

sell 1 in the money put

buy 2 out the money puts

a 2:1 put backspread can be implemented by buying a number of puts at a higher strike and buying twice the number of puts at a lower strike.
unlimited profit potential
this strategy profits when the stock price makes a strong move to the downside beyond the lower breakeven point. there is no limit to the maximum possible profit for the put backspread.the formula for calculating profit is given below:
 maximum profit = unlimited
 profit achieved when price of underlying
 profit = strike price of long put  price of underlying  max los
limited risk
maximum loss for the put backspread is limited and is incurred when the underlying stock price at expiration is at the strike price of the long puts purchased. at this price, both the long puts expire worthless while the short put expires in the money. maximum loss is equal to the intrinsic value of the short put plus or minus any debit or credit taken when putting on the spread.the formula for calculating maximum loss is given below:
 max loss = strike price of short put  strike price of long put  net premium received + commissions paid
 max loss occurs when price of underlying = strike price of long put
breakeven point(s)
there are 2 breakeven points for the put backspread position. the breakeven points can be calculated using the following formulae. upper breakeven point = strike price of short put
 lower breakeven point = strike price of long put  points of maximum loss
example
suppose xyz stock is trading at $48 in june. an options trader executes a 2:1 put backspread by selling a jul 50 put for $400 and buying two jul 45 puts for $200 each. the net debit/credit taken to enter the trade is zero.
on expiration in july, if xyz stock is trading at $45, both the jul 45 puts expire worthless while the short jul 50 put expires in the money with $500 in intrinsic value. buying back this put to close the position will result in the maximum loss of $500 for the options trader.
if xyz stock drops to $40 on expiration in july, all the options will expire in the money. the short jul 50 put is worth $1000 and needs to be bought back to close the position. since the two jul 45 puts bought is now worth $500 each, their combined value of $1000 is just enough to offset the losses from the written put. therefore, he achieves breakeven at $40.
below $40 though, there will be no limit to the gains possible. for example, at $30, each long jul 45 put will be worth $1500 while his single short jul 50 put is only worth $2000, resulting in a profit of $1000.
if the stock price had rallied to $50 or higher at expiration, all the options involved will expire worthless. since the net debit to put on this trade is zero, there is no resulting loss.
note: while we have covered the use of this strategy with reference to stock options, the put backspread is equally applicable using etf options, index options as well as options on futures.
commissions
for ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
however, for active traders, commissions can eat up a sizable portion of their profits in the long run. if you trade options actively, it is wise to look for a low commissions broker. traders who trade large number of contracts in each trade should check out optionshouse.com as they offer a low fee of only $0.15 per contract (+$8.95 per trade).
Non Synthetic Positions

Long Call Butterfly

Long Futures Position

Short Futures Position

Long Call

Short Call

Bear Spread (call & put)

Bull Spread (call & put)

Long Put

Short Put

Long Straddle

Short Straddle

Long Strangle

Short Strangle

Call Ratio Spread

Put Ratio Spread

Call

Call Ratio Backspread

Put Ratio Backspread

Long Put Butterfly

Short Butterfly

Box Or Conversion/Reversal
Please be aware that trading futures and options involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future results.
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