Put Ratio Spread
ratio put spread
 Details
 Category: nonsynthetic futures and option strategies
 Published on Wednesday, 17 February 2010 22:45
put ratio spread
the put ratio spread is a neutral strategy in options trading that involves buying a number of put options and selling more put options of the same underlying stock and expiration date at a different strike price. it is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.
put ratio spread construction

buy 1 in the money put

sell 2 out the money puts

a 2:1 put ratio spread can be implemented by buying a number of puts at a higher strike and selling twice the number of puts at a lower strike.
limited profit potential
maximum gain for the put ratio spread is limited and is made when the underlying stock price at expiration is at the strike price of the options sold. at this price, both the written puts expire worthless while the long put expires in the money. maximum profit is then equal to the intrinsic value of the long put plus or minus any credit or debit taken when putting on the spread.
the formula for calculating maximum profit is given below:
 max profit = strike price of long put  strike price of short put + net premium received  commissions paid
 max profit achieved when price of underlying = strike price of short put
unlimited downside risk, little or no upside risk
loss occurs when the underlying stock price experiences a sharp decline and drop below the breakeven point at expiration. there is no limit to the maximum possible loss when implementing the put ratio spread.
any risk to the upside for the put ratio spread is limited to the debit taken to put on the spread (if any). there may even be a profit if a credit is received when putting on the spread.
the formula for calculating loss is given below:
 maximum loss = unlimited
 loss occurs when price of underlying
 loss = strike price of short  price of underlying  max profit + commissions paid
breakeven point(s)
there are 2 breakeven points for the put ratio spread position. the breakeven points can be calculated using the following formulae.
 upper breakeven point = strike price of long put +/ net premium received or paid
 lower breakeven point = strike price of short puts  (points of maximum profit / number of uncovered puts)
example
suppose xyz stock is trading at $48 in june. an options trader executes a 2:1 ratio put spread strategy by buying a jul 50 put for $400 and selling 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 long jul 50 put expires in the money with $500 in intrinsic value. selling or exercising this long put will give the options trader his maximum profit of $500.
if xyz stock price drops and is trading at $40 on expiration in july, all the options will expire in the money but because the trader has written more puts than he has purchased, he will need to buy back the written puts which have increased in value. each jul 45 put written is now worth $500. however, his long jul 50 put is worth $1000 and is just enough to offset the losses from the written puts. therefore, he achieves breakeven at $40.
below $40, there will be no limit to the maximum possible loss. for example, at $30, each of the two written jul 45 puts will be worth $1500 while his single long jul 50 put is only worth $2000, resulting in a loss of $1000.
however, there is no upside risk to this trade. 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 ratio spread 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).
the put ratio spread is a neutral strategy in options trading that involves buying a number of put options and selling more put options of the same underlying stock and expiration date at a different strike price. it is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.
put ratio spread construction 
buy 1 itm put sell 2 otm puts 
a 2:1 put ratio spread can be implemented by buying a number of puts at a higher strike and selling twice the number of puts at a lower strike.
limited profit potential
maximum gain for the put ratio spread is limited and is made when the underlying stock price at expiration is at the strike price of the options sold. at this price, both the written puts expire worthless while the long put expires in the money. maximum profit is then equal to the intrinsic value of the long put plus or minus any credit or debit taken when putting on the spread.
the formula for calculating maximum profit is given below:
 max profit = strike price of long put  strike price of short put + net premium received  commissions paid
 max profit achieved when price of underlying = strike price of short put
put ratio spread payoff diagram 
unlimited downside risk, little or no upside risk
loss occurs when the underlying stock price experiences a sharp decline and drop below the breakeven point at expiration. there is no limit to the maximum possible loss when implementing the put ratio spread.
any risk to the upside for the put ratio spread is limited to the debit taken to put on the spread (if any). there may even be a profit if a credit is received when putting on the spread.
the formula for calculating loss is given below:
 maximum loss = unlimited
 loss occurs when price of underlying
 loss = strike price of short  price of underlying  max profit + commissions paid
breakeven point(s)
there are 2 breakeven points for the put ratio spread position. the breakeven points can be calculated using the following formulae.
 upper breakeven point = strike price of long put +/ net premium received or paid
 lower breakeven point = strike price of short puts  (points of maximum profit / number of uncovered puts)
example
suppose xyz stock is trading at $48 in june. an options trader executes a 2:1 ratio put spread strategy by buying a jul 50 put for $400 and selling 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 long jul 50 put expires in the money with $500 in intrinsic value. selling or exercising this long put will give the options trader his maximum profit of $500.
if xyz stock price drops and is trading at $40 on expiration in july, all the options will expire in the money but because the trader has written more puts than he has purchased, he will need to buy back the written puts which have increased in value. each jul 45 put written is now worth $500. however, his long jul 50 put is worth $1000 and is just enough to offset the losses from the written puts. therefore, he achieves breakeven at $40.
below $40, there will be no limit to the maximum possible loss. for example, at $30, each of the two written jul 45 puts will be worth $1500 while his single long jul 50 put is only worth $2000, resulting in a loss of $1000.
however, there is no upside risk to this trade. 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 ratio spread is equally applicable using etf options, index options as well as options on futures.
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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