Put Ratio Spread Explained

Nilesh Jain

30 May 2017

New Page 1

What is Put Ratio Spread?

The Put Ratio Spread is a premium neutral strategy that involves buying options at higher strike and selling more options at lower strike of the same underlying stock.

When to initiate the Put Ratio Spread

The Put Ratio Spread is used when an option trader thinks that the underlying asset will fall moderately in the near term only up to the sold strike. This strategy is basically used to reduce the upfront costs of premium and in some cases upfront credit can also be received.

How to construct the Put Ratio Spread?

  • Buy 1 ITM/ATM Put
  • Sell 2 OTM Put

The Put Ratio Spread is implemented by buying one In-the-Money (ITM) or At-the-Money (ATM) put option and simultaneously selling two Out-the-Money (OTM) put options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy Put Ratio Spread
Market Outlook Moderately bearish with less volatility
Upper Breakeven Long put strike (-/+) Net premium paid or received
Lower Breakeven Short put strike - Difference between Long and Short strikes (-/+) premium received or paid
Risk Unlimited
Reward Limited (when underlying price = strike price of short put)
Margin required Yes

Let’s try to understand with an Example:

NIFTY Current market Price Rs 9300
Buy ATM Put (Strike Price) Rs 9300
Premium Paid (per share) Rs 140
Sell OTM Put (Strike Price) Rs 9200
Premium Received Rs 70
Net Premium Paid/Received Rs 0
Upper BEP 9300
Lower BEP 9100
Lot Size 75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will fall to 9200 on expiry, then he can initiate Put Ratio Spread by buying one lot of 9300 put strike price at Rs 140 and simultaneously selling two lot of 9200 put strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be Rs 7500 (100*75). It would only occur when the underlying asset expires at 9200. In this case, short put options strike will expire worthless and 9300 strike will have some intrinsic value in it. However, maximum loss would be unlimited if it breaches breakeven point on downside.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Put Bought (Rs)

Net Payoff from 9200 Put Sold (Rs) (2Lots)

Net Payoff (Rs)

8700

460

860

-400

8800

360

660

-300

8900

260

460

-200

9000

160

-260

-100

9100

60

-60

0

9150

10

40

50

9200

-40

140

100

9250

-90

140

50

9300

-140

140

0

9350

-140

140

0

9400

-140

140

0

9450

-140

140

0

9500

-140

140

0

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Put Ratio Spread, then the Delta would be positive, which means any upside movement will result into marginal profit and any major downside movement will result into huge loss.

If the net premium is paid, then the Delta would be negative, which means any upside movement will result into premium loss, whereas a big downside movement is required to incur huge loss.

Vega: The Put Ratio Spread has a negative Vega. An increase in implied volatility will have a negative impact.

Theta: With the passage of time, Theta will have a positive impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Put Ratio Spread has short Gamma position, which means any major downside movement will affect the profitability of the strategy.

How to manage Risk?

The Put Ratio Spread is exposed to unlimited risk if underlying asset breaks lower breakeven hence one should follow strict stop loss to limit losses.

Analysis of Put Ratio Spread:

The Put Ratio Spread is best to use when investor is moderately bearish because investor will make maximum profit only when stock price expires at lower (sold) strike. Although your profits will be none to limited if price rises higher.

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mutual-fund

Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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Put Ratio Spread Explained

Nilesh Jain

30 May 2017

New Page 1

What is Put Ratio Spread?

The Put Ratio Spread is a premium neutral strategy that involves buying options at higher strike and selling more options at lower strike of the same underlying stock.

When to initiate the Put Ratio Spread

The Put Ratio Spread is used when an option trader thinks that the underlying asset will fall moderately in the near term only up to the sold strike. This strategy is basically used to reduce the upfront costs of premium and in some cases upfront credit can also be received.

How to construct the Put Ratio Spread?

  • Buy 1 ITM/ATM Put
  • Sell 2 OTM Put

The Put Ratio Spread is implemented by buying one In-the-Money (ITM) or At-the-Money (ATM) put option and simultaneously selling two Out-the-Money (OTM) put options of the same underlying asset with the same expiry. Strike price can be customized as per the convenience of the trader.

Strategy Put Ratio Spread
Market Outlook Moderately bearish with less volatility
Upper Breakeven Long put strike (-/+) Net premium paid or received
Lower Breakeven Short put strike - Difference between Long and Short strikes (-/+) premium received or paid
Risk Unlimited
Reward Limited (when underlying price = strike price of short put)
Margin required Yes

Let’s try to understand with an Example:

NIFTY Current market Price Rs 9300
Buy ATM Put (Strike Price) Rs 9300
Premium Paid (per share) Rs 140
Sell OTM Put (Strike Price) Rs 9200
Premium Received Rs 70
Net Premium Paid/Received Rs 0
Upper BEP 9300
Lower BEP 9100
Lot Size 75

Suppose Nifty is trading at Rs 9300. If Mr. A believes that price will fall to 9200 on expiry, then he can initiate Put Ratio Spread by buying one lot of 9300 put strike price at Rs 140 and simultaneously selling two lot of 9200 put strike price at Rs 70. The net premium paid/received to initiate this trade is zero. Maximum profit from the above example would be Rs 7500 (100*75). It would only occur when the underlying asset expires at 9200. In this case, short put options strike will expire worthless and 9300 strike will have some intrinsic value in it. However, maximum loss would be unlimited if it breaches breakeven point on downside.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at

Net Payoff from 9300 Put Bought (Rs)

Net Payoff from 9200 Put Sold (Rs) (2Lots)

Net Payoff (Rs)

8700

460

860

-400

8800

360

660

-300

8900

260

460

-200

9000

160

-260

-100

9100

60

-60

0

9150

10

40

50

9200

-40

140

100

9250

-90

140

50

9300

-140

140

0

9350

-140

140

0

9400

-140

140

0

9450

-140

140

0

9500

-140

140

0

The Payoff Graph:

Impact of Options Greeks:

Delta: If the net premium is received from the Put Ratio Spread, then the Delta would be positive, which means any upside movement will result into marginal profit and any major downside movement will result into huge loss.

If the net premium is paid, then the Delta would be negative, which means any upside movement will result into premium loss, whereas a big downside movement is required to incur huge loss.

Vega: The Put Ratio Spread has a negative Vega. An increase in implied volatility will have a negative impact.

Theta: With the passage of time, Theta will have a positive impact on the strategy because option premium will erode as the expiration dates draws nearer.

Gamma: The Put Ratio Spread has short Gamma position, which means any major downside movement will affect the profitability of the strategy.

How to manage Risk?

The Put Ratio Spread is exposed to unlimited risk if underlying asset breaks lower breakeven hence one should follow strict stop loss to limit losses.

Analysis of Put Ratio Spread:

The Put Ratio Spread is best to use when investor is moderately bearish because investor will make maximum profit only when stock price expires at lower (sold) strike. Although your profits will be none to limited if price rises higher.

Have Referral Code?