Put Ratio Backspread is almost the precise opposite of the Call Ratio
Backspread. It enables us to make accelerated profits, provided that the stock
moves sharply downwards. Increasing volatility is very helpful because we’re
net long in puts. The worst thing that can happen is that the stock doesn’t
move at all, and even a sharp move up can be profitable, or at the very least,
preferable to no movement at all.
Put Ratio Backspread involves buying and selling different numbers of the same
expiration puts. Typically we buy and sell puts in a ratio of 2:1 or 3:2, so we
are always a net buyer. This gives us the uncapped profit potential. It also
reduces the net cost of doing the deal such that we can even create a net
credit! Furthermore, our risk is capped, though we need to investigate the
strategy further in order to understand it better.
this strategy when you are in a bearish environment, believe the stock price
will radically drop, and want capital gains.
is trading at $27.98 on May 10, 2011.
two January 2012 25 strike puts at $2.15.
one January 2012 30 strike put at $4.20
benefit of this strategy is that you have reduced your cost of the trade while
capping your risk and benefiting from higher leverage as the stock drops.
risk is the difference between strikes minus net credit, multiplied by the
number of contracts you are selling. The reward would be unlimited until the
stock drops to zero.
until the stock drops to zero.
in strikes minus net credit received, or plus net debit paid.
even up: higher strike minus net credit.
even down: lower strike minus difference in strike prices times the number of
short puts, divided by the number of long puts minus number of short puts, plus
net credit or minus net debit paid.
Of Time Decay
You need time because you are looking for a significant move.
the stock goes above the stop loss, unravel the position.
out the entire position at least one month in advance of expiration to stem
losses or capture profit.
out entire position by buying back the puts sold and selling the puts bought.