The Ultimate Guide To Put Ratio Backspreads

A put ratio backspread is an option trade that involves selling put options and buying a larger number of put options on the same instrument and the same expiration date. The name of the trade comes from the ratio between the number of long and short positions.

The put ratio backspread (or reverse put ratio spread) is a bearish strategy that is created when the trader thinks that the stock will suffer a significant downside movement. The most common ratio in put ratio backspreads is two-to-one, where there are twice as many long puts as short ones.

The strategy involves selling an out-the-money (OTM) put and buying two or more puts at a lower price, usually in-the-money (ITM), while having the same expiration. The strategy is usually initiated for a net credit, as this permits the trade to make a small gain even when the stock price moves higher. The strategy is long vega and benefits from a rise in implied volatility.

If the trade is made for a credit, there is no upside risk in the trade. There a is limited risk on the downside if the stock moves closer to the strike price of the long put, or if the implied volatility decreases. The put ratio backspread is considered a bearish strategy that some traders prefer to use instead of buying puts.

Some investors prefer this strategy over buying long puts because the trade can be initiated for a credit. Here is an example of a BP put ratio backspread.

Maximum Loss

The maximum loss occurs when the stock is at the strike price of the long puts while at expiry. The maximum loss is equal to the intrinsic value of the short plus, or minus the net debit or credit received when the trade was initiated.

In the BP case, there is no loss on the upside because the trade was created for a credit. If the trade was created for credit, the maximum loss is:

  • Maximum loss = Strike price short put – strike price long put – Net credit received.

Our BP put ratio backspread was initiated for a credit of $255. The short BP 18 put and the long BP 16 put are $2 apart. The maximum loss of the trade would be:

  • Max loss = $2000 – $255 = $1745.

If the trade was initiated for a debit, the maximum loss would be:

  • Maximum loss = Strike price short – strike price long puts + Net premium paid.

Maximum Gain

The maximum gain happens when the stock price drops to zero. If this improbable situation occurs, the short put would expire at the money, as well as the long puts.

  • Max Gain = Long put price – (Short put price strike – Long put price strike) + Net credit.

In our BP trade, the maximum gain is:

  • 10 × ($16 – $2 + $0.255) x 100 = $14,255.

Breakeven Price

If the put ratio backspread is established for a credit, there are two breakeven prices which are:

  1. Upper breakeven price = strike price of the short put – net credit received.
  2. Lower breakeven price = strike price long put – (strike price short put – strike price long put) + net credit received.
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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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