Put Ratio Backspread

The put ratio backspread is a relatively complicated option strategy that involves simultaneously buying and selling puts. The "ratio" part comes in because you buy more puts than you sell...the ratio of which determines the structure of the trade.

When you sell an options contract, you collect a premium, i.e. you get paid money in the deal. When you buy one, you have to pay out. Those details might sound a little basic, but they're crucial for explaining the way this setup works.

In setting up the put ratio backspread, you are selling puts in order to pay for other puts you want to buy. Usually, a trader will try to secure a slight gain from the initial buying and selling transactions, so that if all else fails, they will be sure of that small profit. However, trades often get set up with a mild deficit at the start, with the trader hoping to make it up by guessing correctly about the movement of the underlying asset.

Shares of Poot Limited are trading at $20. Puts with a strike price of $21 are trading at $2. Puts with a strike price of $19 are trading at $75. You sell one put with a strike price of $21, bringing yourself $2 in the transaction. Meanwhile, you buy two puts with the $19 strike price, for which you have to pay $0.75 for each. You've earned a premium of $2 from the sale, while the puts you bought cost you a total of $1.50. You're up $0.50 so far. (This is all multiplied by 100, because any option contract applies to 100 shares; your total gain on the deal so far is $50).

Now, if the stock falls below $19, the two puts you bought will pay off. If it doesn't drop, you've still got the small profit you secured from the initial transactions.