Put is a bearish option strategy with a possibility of good percentage
gains to the downside and limited loss to the upside.
option-info and options-graphs sites:
Ratio Put Spread
Outlook: Bearish. The position will gain if the stock falls by at
least the amount of the initial debit. But, not too bearish, since the
position can lose on too much of a move.
Buy an ATM put, sell two OTM puts.
when: Stock falls but not too far.
Gain: Limited to the difference in strike prices less the initial
when: Stock does not fall or falls too much.
Loss : Unlimited.
Calculation: Upper breakeven: long strike - initial debit. Lower breakeven:
short strike - difference in strike prices + initial debit.
compared to short stock: Leverage, limited loss to upside.
compared to short stock: Loss if stock falls too far.
after entry, increasing implied volatility is negative.
after entry, the passage of time is positive.
Requirement : Your broker will see this trade as a bear put and naked
short puts. The bear put requires no margin, but the naked short puts
will require a minimum of 10% of the strike price plus the premium received,
and probably more.
The short strike can be anywhere you wish, with the long strike above
that. Wherever you put the short strike, that is where the "sweet
spot" will be.
- This strategy
might be used if you thought there was a good chance of the stock falling
to the short strike before expiration, but not further.
- The intent
of this trade is to be bearish by owning a long put, but help pay for
the put by selling two puts at a lower strike.
- It is
possible to enter this strategy for a credit when the implied volatility
is high. If you enter for a credit, there is no risk to the upside,
and the strategy will benefit from any drop in the implied volatility.
However, the implied volatility being high may be a sign the market
thinks the stock might have a good move lower, which would cause a loss
for the position.
using this strategy, consider adding an inexpensive long put at a lower
strike. That turns the trade into a Butterfly.
The Butterfly will maintain about the same risk and reward over the
bearish price move you expect, without the unlimited risk if the stock
falls too much.
- Also compare
this strategy to a Bear Put,
ATM. The entry debit will be higher, but if the stock falls more
than you think it will, you can keep the gains instead of giving them
all back or having a loss.
- This is
a psychologically difficult trade. If the stock moves lower as you expect
and reaches the short strike before expiration, you may not know what
to do. If you hold on and the stock stays where it is, your gains will
increase quite a bit just by the passage of time. But if the stock moves
higher or lower, you start giving back the gains. The best course of
action might be to exit the trade if the stock reaches the short strike
price, whenever that is.
- If the
stock rises instead of falling, you might try to take about half the
maximum loss whenever that happens.
- If the
stock falls near the short strike, it is possible to stick with the
trade by shorting enough stock to cover half the short puts. Then there
is no further risk of loss to the downside, and you may be able to keep
the entire gain as if you had entered a bear put.
However, you would then have a lot of short stock risk and would lose
if the stock reversed to the upside.