Seasoned options traders know that a put ratio spread is an advanced option trade and is generally not suitable for beginners. But the strategy can have its place within an option portfolio. Let's investigate this advanced trading technique with Boeing stock in mind.
According to IBD Stock Checkup, Boeing ranks No. 30 in its group. The stock holds a Composite Rating of 29, an EPS Rating of 6 and a Relative Strength Rating of 69.
Generally considered a neutral strategy, the put ratio spread carries the ability to make a profit in up, down and sideways markets. Yes, it can make money no matter which way the market goes. But the key is the timing!
The strategy involves buying a put option and selling two put options further out of the money. The time to place the trade? When a trader thinks the underlying stock will be stable or slowly move lower and finish around the short put strike at expiry.
A fall in implied volatility will benefit the trade. It can also be profitable if the stock moves up early in the trade.
The main risk with the trade: a sharp move lower early in the trade.
Boeing Stock: Setting Up A Put Ratio Spread
On Boeing stock, we could buy the Oct. 21-expiring put with a strike price of 140 for around $3.25 and sell two Oct. 21, 130-strike put option contracts for around $1.75 each. As we are selling 2 contracts at $1.75 the trade results in a net credit of $0.25 per share, or $25.
Note this is the maximum gain above a stock price of 140. Basically, all the puts would expire worthless, and the trader keeps the $25 premium.
A tent-shaped profit zone exists between 120 and 140 with the maximum gain occurring at 130 and is around $1,000.
This strategy should move fairly slowly, unless there is a sharp drop in the stock price. The trade starts with a delta of 3, which means it is roughly equivalent to owning 3 shares of BA stock, although this will change as the trade progresses.
As the trade in Boeing stock involves naked options, beginning traders may want to first try this trade in a virtual account. In terms of a stop loss, I would close the trade if it was down $200.
Please remember that options are risky, and investors can lose 100% of their investment.
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 setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
