A put ratio spread is an advanced option trade and is generally not suitable for beginners, but it can have its place within an option portfolio.
It is generally considered a slightly bullish strategy, although it has the ability to potentially make a profit in up, down and sideways markets.
Yes, it can make money no matter which way the market goes. The key is the timing!
The strategy involves buying a put option and selling two put options further out-of-the-money.
Multiple Ways To Profit From Trade
The trade is placed when the trader thinks the underlying stock will be stable and not drop below the short-put strike at expiry.
A fall in implied volatility will benefit the trade, and it can also be profitable if the stock moves up early in the trade. The main risk with the trade is a sharp move lower early in the trade.
Let's look at an example using Microsoft.
With Microsoft stock, we could buy the March 15 put with a strike price of 400 for around $4.80 (using quotes from late Wednesday) and sell 2 of the March 15, 310-strike puts for around $2.50.
Because we are selling 2 contracts at $2.50 each, the trade results in a net credit of $0.20 per share ($2.50 x 2 = $5-$4.80 = $0.20).
This is the maximum gain above a stock price of 400. Basically, all the puts would expire worthless, and the trader keeps the $20 premium (for a block of 100 shares).
A tent-shaped profit zone exists between 380 and 400, with the maximum gain occurring at 390, for around $1,000.
Equal To 6 Shares Of Microsoft Stock
This strategy should move fairly slowly unless there is a sharp drop in the stock price. The trade starts with a delta of 6. That means it is roughly equivalent to owning six shares of Microsoft stock, although this will change as the trade progresses.
Because the trade involves naked options, it is not recommended for beginners.
In terms of a stop loss, I would close the trade if it was down $300.
According to the IBD Stock Checkup, Microsoft stock is ranked No. 1 in its industry group. It has a Composite Rating of 95, an EPS Rating of 97 and a Relative Strength Rating of 88.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setup is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
