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 (more contracts) + Buy Put (less contracts)
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The idea behind Ratio Put Spread is to reduce risks of selling Naked Put with buying Put and the number of contracts for Sell Put must be bigger than Buy Put. Common ratios are 2:1 and 3:2 (3:1 and 4:1 are riskier). In other words, it’s a combination of Bear Put Spread and Naked Put.
We will achieve the maximum profit provided that the stock’s price is between the two strike prices of bought leg and sold leg (or if the stock’s price stays at strike price of bought leg) at the expiration day.
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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) = ($2,000) + $3,000 = $1,000
Breakeven Point Down = (Strike Price of Bought Leg – Spread Difference x No of Contracts sold) + Net Debit = ($32.50 – ($2.50 x 2)) + $0.20 = $27.50 + $0.20 = $27.90
Breakeven Point Up = Strike Price of Bought Leg – (Net Debit x No of Contracts Bought) = $32.50 – ($0.20 x 1) = $32.50 – $0.20 = $32.30
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 = $ 0 + $12,500 - $1,000 = $11,500
Return of Investment = Profit @ Exit / Investment @ Entry = 1,150%
Worst Case Scenario : Unlimited Loss
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