Put Ratio Spread
The put ratio spread is considered a neutral strategy because you do not want movement in stocks in this strategy. The ratio spread is a good strategy if you are anticipating a relatively stable price in a short period of time. To create the spread, you need more short options than long options. If you are not familiar with long and short options, you might want to review the call back spread.
To create a put ratio spread, you will purchase puts at higher strike and then sell puts at lower strike. This is best done with small credit because if the price of the stock increases, you will not have to pay much because the puts will simply be worthless. On the other hand, if the stock drops, you now have unlimited risk. You will now have to sell more options than what you have. For optimum profitability, your stock price should be the same as the strike price on your short options.
For example, supposing ABC stock is trading at $79.36:
|ABC trading @ $79.36|
|Buy 1 ABC JUL 120 Put @ $10.60||$2,120.00|
|Sell 3 ABC JUL 80 Put @ $4.80||($1,440.00)|
Here you will have to pay $680 for the trade. If the stock reaches above 120, you will lose $680. If it stayed around $80, the short puts will expire with no value and the long put will be $20. The value of the put less the $680 debit will bring you a profit of $1,320. Big move on the downside would mean loss. The downside breakeven point will be when the stock price is $73.40. Below this point, you run the risk of losing a lot of money.
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