Put Ratio Backspread

  

Categories: Derivatives

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.

Related or Semi-related Video

Finance: What Is a Put Option?83 Views

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finance a la shmoop what is a put option? hot potato hot potato

00:07

ow ow! yeah remember that game well nobody wanted the potato, poor thing. the

00:11

players wanted to put it in someone else's hands. well put options kind [glue put around a flaming potato]

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of work the same way. a put option is the right or option or choice to sell a

00:24

stock or a bond at a given price to someone by a certain end date.

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all right example time. you bought netflix stock at the IPO a zillion years

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ago at $1 a share. that's you know splits adjusted. all right now it's a hundred

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bucks a share. if you sell it you pay taxes on a gain of 99 dollars a share. in

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California that would be a tax of something like almost 40 bucks. well the

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stock was a hundred but you keep only something like 60. feels totally unfair.

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right so you really don't want to sell your stock but you're nervous about the [graph shown]

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next few months that Netflix will crater for a while and go down ten

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maybe twenty dollars. longer term though you think it'll hit 300. so this is the

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perfect setup to maybe look at buying some put options on Netflix. if the stock

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goes down your put options go up. with Netflix volatile but at a hundred bucks

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a share ,you look up the price of an $80 strike price put option expiring in

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December, and you know that's mid-september now .for five bucks a share

01:33

you can protect your stock for the next few months .think about it like temporary [stocks placed in vault]

01:37

term life insurance. you pay the five dollars a share in the stock goes down

01:41

to 82 by mid December, worst of all worlds. well not only did you lose the $5

01:48

a share but your stock has lost $18 in value. but had Netflix really cratered

01:55

and gone to say $60 a share well you would have exercised your put and sold

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your shares at 80 bucks. well those put options you paid $5 for

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would be been worth 15 bucks a share. in buying that put option you've [equation shown]

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guaranteed that your loss will be no more than a $75 value for your Netflix

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position at least for that time period and ignoring taxes. well remember that

02:21

options expire after December whatever like the third Friday of the month it's

02:26

usually when options expire, you then have no protection and your shares float

02:31

along naked. naked? really who knew accounting could get so [paper put option goes "skinny dipping".]

02:36

raunchy. yeah well that's naked put options.

02:40

that's what they really are people.

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