Put Ratio Spread

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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, limited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.

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.

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Loss potential

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.

Breakeven Point(s)

There are 2 break-even points for the Put Ratio Spread position. The breakeven points can be calculated using the following formulae.

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.

These examples use standard U.S. stock options with a 100-share contract size and matching expiration dates. Related structures can use ETF, index or futures options, but contract multipliers, exercise style, settlement and the underlying price range can differ. A stock’s zero price floor must not be assumed for every futures contract.

Commissions

For ease of understanding, these examples exclude commissions, fees and financing costs. Include all costs when comparing an actual position; there is no universal commission amount.

For active traders, transaction costs can consume a significant part of returns. Compare the full commission and fee schedule, exercise and assignment charges, and bid-ask spreads. The cost of entering and closing every leg matters.

Similar Strategies

The following strategies offer related market exposure. Compare their construction, cost, maximum loss and assignment obligations; a similar outlook does not mean identical risk.

Variable Ratio Write

Short Strangle (Sell Strangle)

Short Straddle (Sell Straddle)

Ratio Put Backspread

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.

Call Ratio Spread

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.

Before expiration and assignment

The diagrams and worked outcomes describe expiration payoffs, not an option’s market price before expiration. Time decay, implied volatility, rates, dividends and bid-ask spreads affect early closing values. American-style short options can be assigned early; a protective long option is not automatically exercised when a short leg is assigned. Closing or exercising one leg can change the remaining position’s risk.