Trade options FREE For 60 Days when you Open a New OptionsHouse Account

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.

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

Trade options FREE For 60 Days when you Open a New OptionsHouse Account

Trade options FREE For 60 Days when you Open a New OptionsHouse Account

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 < Strike Price of Short Puts - ((Strike Price of Long Put - Strike Price of Short Put + Net Premium Received) / Number of Uncovered Puts)
- Loss = Strike Price of Short - Price of Underlying - Max Profit + Commissions Paid

There are 2 break-even 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)

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.*

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 (+$4.95 per trade).

The following strategies are similar to the put ratio spread in that they are also low volatility strategies that have limited profit potential and unlimited risk.

The converse strategy to the put ratio spread is the ratio put backspread. Ratio put backspreads are used when large movements is expected of the underlying stock price.

The ratio spread can also be constructed using calls. The call ratio spread is similar to the put ratio spread strategy but has a slightly more bearish and less bullish risk profile.

Open an account at OptionsHouse.com and get 100 commission-free trades + free virtual trading tool!

Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.

Once you start trading for real, your first 100 trades will be commission-free! (Make sure you click thru the link below and quote the promo code '60FREE' during sign-up)

Click here to open a trading account at OptionsHouse.com now!Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®.... [Read on...]

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

OverviewButterfly SpreadCalendar StraddleCondorIron ButterflyIron CondorLong Put ButterflyLong StraddleLong StrangleNeutral Calendar SpreadPut Ratio SpreadRatio Call WriteRatio Put WriteRatio SpreadShort ButterflyShort CondorShort Put ButterflyShort StraddleShort StrangleVariable Ratio WriteReverse Iron CondorReverse Iron ButterflyLong GutsShort GutsLong Call LadderShort Call LadderLong Put LadderShort Put LadderStripStrap

Buying OptionsSelling OptionsOptions SpreadsOptions CombinationsBullish StrategiesBearish StrategiesNeutral StrategiesSynthetic PositionsOptions ArbitrageStrategy FinderStrategy Articles

Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.

Home | About Us | Terms of Use | Disclaimer | Privacy Policy | Sitemap

Copyright 2017. TheOptionsGuide.com - All Rights Reserved.