How to Construct a Put Option Ratio Spread in the Futures Market
Options are eroding assets; therefore, it isn't necessarily wise to spend a substantial amount of money to purchase an option that will face depreciation, as well as dismal odds of success. Instead, it is often a better idea to sell options of different types or strike prices to pay for those that you would like to purchase. A put ratio spread does just that. A trader that is interested in buying a put option in hopes of a market decline, or to simply protect other positions in their trading portfolio, may finance their purchase through the sale of two distant strike priced puts. Here are the details of a put option ratio spread.
Put Ratio Spread
Buy 1 at-the-money Put
Sell 2 or more out-of-the-money Puts
When to Use a 1 by 2 Ratio Put Spread
• Moderately Bearish Option Strategy - When you expect the market to market to move lower, but believe that the downside is limited
• Low Cash Outlay in Exchange for Downside Risk - The objective is to put this trade on as a credit, a free trade or very cheap. This occurs when a trader collects more premium for the short options that is put forth for the long options. Free does not entail a lack of transaction costs, margin or risk.
Ratio Put Spread Profit Profile
• Possible Profit even if the Option Spread Expires Worthless - If executed at a credit the profit is limited to the premium collected if the market is above the long put at expiration
• Limited Profit Potential, but Unlimited Risk - Profit on the down side is limited to the difference between the long and short puts plus the net credit or minus the net debit. The risk is theoretifcally unlimited on the downside.
What is the Risk of Trading a Put Ratio Write?
• If the market expires above the long put your risk is limited to any premium paid for the spread if executed as a debit
• Because this trade involves more short puts than long the down side risk is unlimited below the short puts
• Having unlimited risk this trade needs to be watched closely
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