Description
A Put Ratio Spread
is a unique "bearish"
strategy. It involves
a bearish strategy
[Bear Put Spread]
along with a bullish
strategy [Short
Put]. A stock investor
who is currently
bearish on XYZ could
use this strategy
to profit from a
decline and/or own
stock in XYZ at
much lower prices.
When to use
Most attractive
when XYZ is between
the two strike prices
(e.g., 55-60). If
XYZ is at or below
the lower strike
(55), spread may
not be attractive
because XYZ is already
too close to point
where stock ownership
is likely. Alternatively,
if XYZ is at or
above higher strike
(60), spread must
often be established
for a larger debit.
The expiration month
selected has a large
impact on whether
the spread is established
for a debit or a
credit. The more
time until the options'
expiration, the
smaller the cost
of the spread.
Risk/Reward
Characteristics
The spread has
limited upside risk.
If the spread is
established for
a debit, that is
the maximum the
investor can lose
if XYZ is above
$60 at expiration.
If done for a credit,
there is no upside
risk. Because stock
ownership is possible,
the downside risk
can be large if
XYZ has a large
decline before expiration.
Maximum profit potential
= strike price differential
x number of long
Puts - net total
$ debit (or plus
net total $ credit).
Break-even
Point: If a
debit spread, upside
break-even point
is equal to the
strike price of
the long Put minus
the position's net
debit. Downside
break-even point
is equal to the
lower strike price
minus (maximum profit
potential / # of
naked Puts).
Time Decay:
Varies. If XYZ is
near the strike
price of the two
written Puts (55),
profits from decay
accelerate most
rapidly over time.
If near strike of
long Put, impact
is negative.
Volatility:
An increase in volatility
is a negative for
this spread. The
impact will depend
to a large part
on both the amount
of time left until
expiration and the
price of XYZ relative
to the two strike
prices.
Assignment
Risk: In that
this spread contains
written Puts (one
covered and one
uncovered), the
investor must watch
XYZ for possible
assignment if XYZ
is below the lower
strike price as
expiration approaches.
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