A Put Ratio Spread involves buying a number of puts at a higher strike price and sells more puts at a lower strike price of the same underlying and same expiry.
A good rule of thumb is to use a 2:1 put ratio, by selling twice the number of puts as buying.
When to use this strategy?
This strategy is used when the investor is neutral to slightly bearish on the undelrying security and is expecting little volatility in the short term.
How to build this strategy?
This strategy has two legs:
Leg 1 – Buy 1 ITM Put
Leg 2 – Sell 2 OTM Puts
Credit Spread/Debit Spread
This is variable.
The profit potential in this strategy is limited.
When is this strategy profitable?
The investor earns a profit when price of the underlying security at expiry is equal to the strike price of the call options sold.
The investor faces unlimited risk in this strategy.
When is this strategy unprofitable?
The investor will have to face large losses if the price of the undelrying security declines sharply.