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Put Ratio Back Spread option strategy - How and When to Implement

The Put Ratio back spread is an option strategy, executed the best when your outlook towards the stock or index is bearish. The strategy requires to sell 1 ITM PE and buy 2 OTM PE, and this is to be executed in the same ratio i.e for every 1 option sold, 2 options have to be purchased. This gives you limited money when the scrip goes up, but the profit is unlimited when the price of the stock goes down. It is executed for Net Credit.
Construction
Sell 1 Lot ITM Put
Buy 2 Lots OTM put

Example


Taking an example of Nifty which is trading at 8083. To implement the Put Ratio Back Spread, one can sell 1 lot of 8100 strike Put with premium Rs. 216 and can buy 2 lots of 7700 strike put with premium 89 each. There will be a net Credit of  38.

Particular
Value
Underlying
Nifty
Spot Price
8083
ITM Put, Sell
8100
OTM Put, Buy
7700
Credit (ITM)
216
Debit (2 OTM)
89
Net Credit
38

There will a spread of 400 points. We will have two break-even points in the strategy. The Upper break-even will be around 8062 and the lower break-even will be at 7338. See the table given below. This gives an unlimited profit when it goes significantly down. The maximum loss occurs when Nifty expires at 7700. 

Details


Spread

400
Lower Breakeven

7338
Upper Breakeven

8062
Max Loss

362
Max Loss level

7700
Max Profit

Unlimited


 Pay Offs of the strategy

Calculation for The strategy

Market Expiry
ITM_IV
PR
ITM Payoff
OTM_IV
PP
OTM_Payoff
Strategy Payoff
7000
1100
216
-884
1400
178
1222
338
7100
1000
216
-784
1200
178
1022
238
7200
900
216
-684
1000
178
822
138
7300
800
216
-584
800
178
622
38
7400
700
216
-484
600
178
422
-62
7500
600
216
-384
400
178
222
-162
7600
500
216
-284
200
178
22
-262
7700
400
216
-184
0
178
-178
-362
7800
300
216
-84
0
178
-178
-262
7900
200
216
16
0
178
-178
-162
8000
100
216
116
0
178
-178
-62
8100
0
216
216
0
178
-178
38
8200
0
216
216
0
178
-178
38
8300
0
216
216
0
178
-178
38
8400
0
216
216
0
178
-178
38
8500
0
216
216
0
178
-178
38


If you see the table carefully, you will find that, if Nifty expires anywhere above 8100, there will be a constant profit of Rs. 38. If Nifty expires at 7300 or below that we are getting profit Rs. 38 to unlimited. The maximum loss occurs at 7700 level - The level of which puts have been bought. If Nifty expires anywhere in the range of 8000 to 7400, will give you a loss.


You can also see the Maximum Loss is constant which is at Rs. 362. How does it come?
2 OTM PUT = 2*89 = 178

If Nifty expires 7700, we will have 0 premium for this two OTMs. For the ITM put we will have intrinsic value,
= 8100 - 7700 = Rs. 400.
At 400 we have to buy this position to close the strategy. So in this case loss,
= 400 - 216 (received at selling) = 184.
Thus,
Total Loss = 178 + 184 = Rs. 362.

 These posts can be recommended for you.
How to monetize Volatility
Volatility Rank and Volatility Percentile
How to read Option data for trading

Disclaimer: The post has been prepared for informational and educational purposes only. It is not and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action.
Put Ratio Back Spread option strategy - How and When to Implement Reviewed by Kumar Chandan on April 05, 2020 Rating: 5

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