Ratio
Put Spread
Description
The
Ratio Put Spread is the opposite of a Put Ratio Backspread in that we are net
short options. This means we are exposed to uncapped risk and can only make a limited
reward. As such, this is an undesirable strategy, and you’d be better off
trading one of the long butterflies.
The
Ratio Put Spread involves buying and selling different numbers of the same
expiration puts. Typically we sell and buy puts in a ratio of 2:1 or 3:2, so we
are always a net seller. This gives us the uncapped risk potential. It also
reduces the net cost of doing the deal such that we create a net credit.
Market
Opinion
Neutral
to bullish.
P/L
Profile
When
To Use
This
is an income strategy. You are looking for a net credit if the stock stays
within a range or rises.
Example
XXXX
is trading at $27.65 on May 10, 2011.
Sell
two June 2011 25 strike puts at $0.42.
Buy
one June 2011 $27.50 strike put at $1.33.
Benefit
This
position will be profitable if the stock stays within a range.
Risk
vs. Reward
There
is unlimited risk in this position, with capped reward.
Net
Upside
The
difference between the strike prices plus the net credit.
Net
Downside
Unlimited
downside.
Break
Even Point
Break
even up: Higher strike price minus net debit times the number of long
contracts.
Break
even down: Higher strike price minus the difference in strike prices, times the
number of short contracts, divided by the number of short contracts less long
contracts, minus the net credit received (or plus net debit paid).
Effect
Of Volatility
Increasing
volatility is harmful to this strategy because of our exposure to
uncapped
risk. The best thing that can happen is that the stock doesn’t move at all.
Effect
Of Time Decay
Positive.
You are selling more contracts than buying, and want to be exposed only one
month or less.
Alternatives
Before Expiration
To
stem a loss, if the stock drops under the stop loss, close out the position.
You can also buy back the short puts. This kind of trade is best closed out one
month before expiration to stem losses and capture profit.
Alternatives
After Expiration
Close
out the position by selling the puts bought, and by buying back the puts sold.
