Investment Type: credit/debit
Strike Prices: OTM for bought leg, further OTM for sold leg
Expiration Month: Same expiration month between sold leg and bought leg, preferably current month.
Composition: Sell Put (less contracts) + Buy Put (more contracts)
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Put Ratio Backspread is the opposite of Ratio Put Spread. It is an interesting strategy because if we are able to pull off a net credit from the trade, then we will able to achieve uncapped rewards and if market goes against us, we still profit from the net credit. However we suffer loss if the stock moves sideways.
The process with this strategy is that we Buy OTM Put, then we try to offset the cost needed with Sell ITM Put. But make sure that the number of contracts for sold leg is smaller than bought leg. Common ratios are 1:2 and 2:3 (1:3 and 1:4 will lower the risk and shift the breakeven point). It’s essential that the maximum risk is still within the rule of our money management.
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Entry:
Investment @ Entry = (Premium of Sold Leg x No of Contracts x 100 Shares) + (Premium of Bought Leg x No of Contracts x 100 Shares) = ($4,250) + $3,000 = Credit ($1,250)
Breakeven Point Down = Strike Price of Sold Leg (lower strike) – (Difference in Strikes - Net Credit) = $32.5 – ($2.50 - $0.50) = $30.50
Exit:
Best Case Scenario:
Profit @ Exit (Premium of Sold Leg x No of Contracts x 100 Shares) + (Premium of Bought Leg x No of Contracts x 100 Shares) - Investment @ Entry = ($18750) + $25,000 – ($1,250) = $7,500
Return of investment = Profit @ Exit / Investment @ Entry = 600%
Worst Case Scenario : (Difference between Strike Prices – Net Credit) x No of Contracts
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