Posted in Finance, Accounting and Economics Terms, Total Reads: 1000

It is an option trading strategy where one takes both short put and long put and the profit/loss of his/her position is determined by the ratio of those puts. As the option investor determines the puts ratio and he/she derives profit from the volatility of underlying asset it, the name is given as Put ratio Backspread.

The option is designed such that it has a potential to make unlimited profit with limited loss or limited profit with unlimited loss depending upon the preference of the investor. Typical ratios are (long put : Short put) 3:2, 2:1, 3:1

For example: Take a stock which is treading at \$29.50. It has following one month puts:

1. Exercise price= \$30

Option price= \$1.16

2. Exercise price= \$29

Option price= 62 cents

Now an investor who is bearish on the stock would set a 2:1 put ratio stock spread:

Considering each option contract has 100 shares,

Long on two \$29 put contract= (\$.62*2*100) = (\$124)

Short on one \$30 put contract= \$1.16*100= \$116

Net cost= \$8

On expiry:

Case 1:

Stock price=27

Gain(in \$)= (29-27)*200-(30-27)*1000-8 =92

Case 2:

Stock Price=31

No one will get exercised

Loss(in \$)=8

Hence, this concludes the definition of Put Ratio Backspread along with its overview.

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