Ratio Put Write Explained

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Ratio Put Write

The ratio put write is a neutral strategy in options trading in which the options trader short sell the underlying stock and sells more puts than shares short.

Ratio Put Write Construction
Short 100 Shares
Sell 2 ATM Puts

Like the ratio call write, it is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock price will experience little volatility in the near term.

Profit/Loss Potential

This strategy has the same risk/reward profile as the ratio call write. However, it is a highly inferior strategy because, firstly, while the ratio call writer gets to enjoy dividends, the ratio put writer has to pay them. Secondly, call options generally command higher premiums than put options.

The formula for calculating maximum profit is given below:

  • Max Profit = Net Premium Received – Commissions Paid
  • Max Profit Achieved When Price of Underlying = Strike Price of Short Puts

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying Strike Price of Short Put + Net Premium Received
  • Loss = Price of Underlying – Sale Price of Underlying – Net Premium Received OR Strike Price of Short Put – Price of Underlying – Net Premium Received + Commissions Paid

Breakeven Point(s)

There are 2 break-even points for the ratio put write position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Strike Price of Short Puts + Points of Maximum Profit
  • Lower Breakeven Point = Strike Price of Short Puts – Points of Maximum Profit

Note: While we have covered the use of this strategy with reference to stock options, the ratio put write is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

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Similar Strategies

The following strategies are similar to the ratio put write in that they are also low volatility strategies that have limited profit potential and unlimited risk.

Ratio Call Write

The ratio call write is a neutral strategy in options trading in which the options trader owns a holding of the underlying stock and sells more calls than shares owned. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock price will experience little volatility in the near term.

Ratio Call Write Construction
Long 100 Shares
Sell 2 ATM Calls

A 2:1 call ratio write can be implemented by selling 2 at-the-money calls for every 100 shares owned.

Limited Profit Potential

Maximum profit for the ratio call write is limited and is made when the underlying stock price at expiration is at the strike price of the options sold. At this price, both the written calls expire worthless while the value of the long stock position remains unchanged. As such, the options trader gets to keep all of the premiums received when putting on the trade. Thus, maximum profit is equal to the premiums received from the sale of call options.

The formula for calculating maximum profit is given below:

  • Max Profit = Net Premium Received – Commissions Paid
  • Max Profit Achieved When Price of Underlying = Strike Price of Short Calls

Unlimited Risk Potential

Loss occurs when the stock price makes a strong move to the upside or downside beyond the upper and lower breakeven points. There is no limit to the maximum possible loss for the ratio call write.

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying Strike Price of Short Call + Net Premium Received
  • Loss = Price of Underlying – Strike Price of Short Call – Net Premium Received OR Purchase Price of Underlying – Price of Underlying – Net Premium Received + Commissions Paid

Breakeven Point(s)

There are 2 break-even points for the ratio call write position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Strike Price of Short Calls + Points of Maximum Profit
  • Lower Breakeven Point = Strike Price of Short Calls – Points of Maximum Profit

Using the graph shown above, since the maximum profit is $400, points of maximum profit is therefore equals to 4. Therefore, upper breakeven is at $49 while lower breakeven is at $41.

Example

Suppose XYZ stock is trading at $45 in June. An options trader executes a 2:1 ratio call write strategy by buying 100 shares of XYZ stock for $4500 and selling two at-the-money JUL 45 calls for $200 each for a total of $400.

On expiration in July, if XYZ stock is still trading at $45, both the JUL 45 calls expire worthless while the long stock position is still worth $4500. At this point, the options trader is positive $400 in the money because of the premiums earned. He can then choose to enter another ratio write or sell the shares and take profit.

If XYZ stock rallies and is trading at $49 on expiration in July, all the call options will expire in the money. The two written JUL 45 call are now worth $400 each. This $800 loss is completely offset by the $400 appreciation of his long stock position and the $400 in premiums he received earlier. Therefore, he achieves breakeven at $49.

Beyond $49 though, there will be no limit to the loss possible. For example, at $60, each written JUL 45 call will be worth $1500, resulting in a combined loss of $3000 on the short position. Meanwhile, his long stock position has only appreciated by $1500 and together with the $400 in premium received, the options trader still need to come up with another $1100 to close the position.

Using the formula for computing the breakeven point, we calculated the lower breakeven point to be $41. At $41, all the call options expire worthless. However, his long stock position also suffers a loss of $400 in value but this loss is offset by the $400 in premiums earned. Therefore, there is breakeven at $41.

Below $41 however, there is no limit to the potential loss. For example, if the stock price is trading at $30 on expiration, while all the call options expire worthless, the long stock position suffers a $1500 drop in value. Even with the $400 in premiums to offset the loss, the options trader still suffers a $1100 loss.

Note: While we have covered the use of this strategy with reference to stock options, the ratio call write is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the ratio call write in that they are also low volatility strategies that have limited profit potential and unlimited risk.

Put Ratio Spread

The put ratio spread is a neutral strategy in options trading that involves buying a number of put options and selling more put options of the same underlying stock and expiration date at a different strike price. It is a limited profit, unlimited risk options trading strategy that is taken when the options trader thinks that the underlying stock will experience little volatility in the near term.

Put Ratio Spread Construction
Buy 1 ITM Put
Sell 2 OTM Puts

A 2:1 put ratio spread can be implemented by buying a number of puts at a higher strike and selling twice the number of puts at a lower strike.

Limited Profit Potential

Maximum gain for the put ratio spread is limited and is made when the underlying stock price at expiration is at the strike price of the options sold. At this price, both the written puts expire worthless while the long put expires in the money. Maximum profit is then equal to the intrinsic value of the long put plus or minus any credit or debit taken when putting on the spread.

The formula for calculating maximum profit is given below:

  • Max Profit = Strike Price of Long Put – Strike Price of Short Put + Net Premium Received – Commissions Paid
  • Max Profit Achieved When Price of Underlying = Strike Price of Short Put

Unlimited Downside Risk, Little or No Upside Risk

Loss occurs when the underlying stock price experiences a sharp decline and drop below the breakeven point at expiration. There is no limit to the maximum possible loss when implementing the put ratio spread.

Any risk to the upside for the put ratio spread is limited to the debit taken to put on the spread (if any). There may even be a profit if a credit is received when putting on the spread.

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying

Breakeven Point(s)

There are 2 break-even points for the put ratio spread position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Strike Price of Long Put +/- Net Premium Received or Paid
  • Lower Breakeven Point = Strike Price of Short Puts – (Points of Maximum Profit / Number of Uncovered Puts)

Example

Suppose XYZ stock is trading at $48 in June. An options trader executes a 2:1 ratio put spread strategy by buying a JUL 50 put for $400 and selling two JUL 45 puts for $200 each. The net debit/credit taken to enter the trade is zero.

On expiration in July, if XYZ stock is trading at $45, both the JUL 45 puts expire worthless while the long JUL 50 put expires in the money with $500 in intrinsic value. Selling or exercising this long put will give the options trader his maximum profit of $500.

If XYZ stock price drops and is trading at $40 on expiration in July, all the options will expire in the money but because the trader has written more puts than he has purchased, he will need to buy back the written puts which have increased in value. Each JUL 45 put written is now worth $500. However, his long JUL 50 put is worth $1000 and is just enough to offset the losses from the written puts. Therefore, he achieves breakeven at $40.

Below $40, there will be no limit to the maximum possible loss. For example, at $30, each of the two written JUL 45 puts will be worth $1500 while his single long JUL 50 put is only worth $2000, resulting in a loss of $1000.

However, there is no upside risk to this trade. If the stock price had rallied to $50 or higher at expiration, all the options involved will expire worthless. Since the net debit to put on this trade is zero, there is no resulting loss.

Note: While we have covered the use of this strategy with reference to stock options, the put ratio spread is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the put ratio spread in that they are also low volatility strategies that have limited profit potential and unlimited risk.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
    Get a Sign-Up Bonus Now!

  • Binomo
    Binomo

    2nd in our ranking!

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