Put Ratio Backspread

AAA

DEFINITION of 'Put Ratio Backspread'

An option trading strategy that combines short puts and long puts to create a position whose profit and loss potential depends on the ratio of these puts. A put ratio backspread is so called because it seeks to profit from the volatility of the underlying stock, and combines short and long puts in a certain ratio at the discretion of the option investor. It is constructed to have unlimited potential profit with limited loss, or limited potential profit with the prospect of unlimited loss, depending on how it is structured. The ratio of long to short puts is typically 2:1, 3:2 or 3:1.

INVESTOPEDIA EXPLAINS 'Put Ratio Backspread'

For example, a stock trading at $29.50 may have one-month puts trading as follows: $30 puts trading at $1.16 and $29 puts trading at 62 cents. A trader who is bearish on the underlying stock and wishes to structure a put ratio backspread that would profit from a decline in the stock, could buy two $29 put contracts for a total cost of $124 and sell short a $30 put contract to receive the $116 premium. (Remember that each option contract represents 100 shares). The net cost of this 2:1 put ratio backspread, without taking commissions into account, is therefore $8.

If the stock declines to $28 at expiration, the trade breaks even (leaving aside the marginal $8 cost of putting on the trade). If the stock falls to $27 at option expiry, the gross gain is $100; at $26, the gross gain is $200 and so on.

If, on the other hand, the stock appreciates to $30 by option expiry, the maximum loss is restricted to the cost of the trade or $8. The loss is restricted to $8 regardless of how high the stock trades by option expiry.

RELATED TERMS
  1. Call Ratio Backspread

    A very bullish investment strategy that combines options to create ...
  2. Spread

    1. The difference between the bid and the ask price of a security ...
  3. Short (or Short Position)

    1. The sale of a borrowed security, commodity or currency with ...
  4. Backspread

    A type of options spread in which a trader holds more long positions ...
  5. Long (or Long Position)

    1. The buying of a security such as a stock, commodity or currency, ...
  6. Put

    An option contract giving the owner the right, but not the obligation, ...
RELATED FAQS
  1. Can I make money using put options when prices are going up?

    It seems counterintuitive that you would be able to profit from an increase in the price of an underlying asset by using ...
Related Articles
  1. Options & Futures

    Options Basics Tutorial

    Discover the world of options, from primary concepts to how options work and why you might use them.
  2. Options & Futures

    The Basics Of The Long Ratio Backspread

    This option trading strategy allows for unlimited profit potential in a given direction while still providing security.
  3. Options & Futures

    Profiting From Stock Declines: Bear Put Spread Vs. Long Put

    If you're bearish, you should compare the risk/reward characteristics of these two strategies.
  4. Options & Futures

    Options Greeks

    Get to know the essential risk measures and profit/loss guideposts in options strategies.
  5. Options & Futures

    Option Spread Strategies

    Learn why option spreads offer trading opportunities with limited risk and greater versatility.
  6. Options & Futures

    Give Yourself More Options With Real Estate Options

    Real estate options have many benefits, including a smaller initial capital requirement.
  7. Options & Futures

    The Fancy Way To Diversify Your Portfolio: Precious Metal Options

    A guide with strategies on how to invest or trade in precious metals by using options.
  8. Options & Futures

    When And How To Take Profits On Options

    Here are the different criteria to ensure maximum profit taking while trading options.
  9. Brokers

    OptionsXpress Vs. OptionsHouse: Which One To Pick?

    OptionsXpress and OptionsBroker -- each offers a price mix and set of services suitable for certain investors based on their trade approach and priorities.
  10. Options & Futures

    The Future Is Now: All About Futures ETFs

    A new security class - futures ETFs - is gaining popularity. We tell you how futures ETFs work and offer tips.

You May Also Like

Hot Definitions
  1. Prepaid Expense

    A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received ...
  2. Gordon Growth Model

    A model for determining the intrinsic value of a stock, based on a future series of dividends that grow at a constant rate. ...
  3. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
  4. Law Of Supply

    A microeconomic law stating that, all other factors being equal, as the price of a good or service increases, the quantity ...
  5. Investment Grade

    A rating that indicates that a municipal or corporate bond has a relatively low risk of default. Bond rating firms, such ...
  6. Fringe Benefits

    A collection of various benefits provided by an employer, which are exempt from taxation as long as certain conditions are ...
Trading Center