When it comes to options trading, investors seek well-rounded strategies to help navigate the dynamic and unpredictable nature of financial markets. One such strategy that is gaining considerable popularity is the put ratio spread. This premium-neutral strategy offers a unique approach to capitalizing on market movements while managing risk effectively.
The put ratio spread is an options trading strategy designed to benefit from a moderately bearish market outlook. At the same time, it also helps with reducing upfront costs or even receiving upfront credit.
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The strategy here involves buying options at a higher strike and selling more options at a lower strike of the same underlying stock. This strategy allows traders to balance their risk exposure and profit from a downward movement in the underlying asset.
To construct a put ratio spread, follow these steps:
Buy 1 In-the-Money (ITM) or At-the-Money (ATM) put option.
Simultaneously sell 2 Out-the-Money (OTM) put options.
Let's consider an example using the NIFTY index:
Assuming the current trading price of NIFTY is Rs 9,500, you anticipate a decrease to Rs 9,400 by the time of expiry. To implement the put ratio spread strategy, you purchase one lot of the 9,500 put strike at Rs 150. Simultaneously you sell two lots of the 9,400 put strike at Rs 75. The net premium paid or received in this trade is zero.
Also, in this scenario, the maximum profit would be Rs 5,625 (75 x 75).
This profit will only occur if the underlying asset expires at Rs 9,400. If this occurs, the short put options strike will have no value, while the 9,500 strike will possess some intrinsic value.
The put ratio spread strategy is suitable for investors who anticipate a bearish market outlook and expect a decline in asset prices. Traders typically initiate a put-back spread after conducting a thorough analysis and evaluating market indicators that suggest potential volatility and downward movement.
Put ratio spreads come with specific risks and rewards. It is therefore crucial to understand them before implementing this strategy -
Implementing risk management techniques is crucial while trading with a put ratio spread. Here are some strategies to manage risk effectively -
Option Greeks play a crucial role in understanding the strategy's sensitivity to different factors -
The put ratio spread is a versatile and powerful options trading strategy. It can help you profit from limited downside moves in the underlying asset while minimising risk. By understanding the mechanics of the strategy, you can make informed decisions about whether the put ratio spread is the right tool for