Introduction: The Strategy's Foundation
The Ratio Put Spread (or Put Backspread) is an advanced, high-leverage strategy used when an investor anticipates a sharp drop in the underlying asset's price, often aiming to execute the trade for a net credit. Unlike the vertical spreads, this strategy involves an unequal number of long and short contracts (a ratio), resulting in uncapped risk on one side of the trade. This strategy is not suitable for beginners.
Let's use a specific example with SPY (the S&P 500 ETF Trust).
Scenario: SPY is currently trading at $680.30. You anticipate a significant drop below $670 by the Dec 19th expiration (39 days).
Goal: You want a cheap way to profit significantly from a large drop, while accepting the risk of a smaller loss if the stock rallies.
Solution: Enter the Ratio Put Spread (e.g., a 1:2 ratio).
2. Strategy Construction: The Ratio and Uncapped Risk
Ratio Put Spread Construction
The Ratio Put Spread is constructed entirely with put options on the same underlying asset and the same expiration date.
Ratio Put Spread = Buy 1 Higher-Strike Put + Sell 2$Lower-Strike Puts (A 1:2 Ratio)
The Long Leg (Protection/Cost): You buy one put option at a higher strike (e.g., at $670).
The Short Leg (Income/Risk): You simultaneously sell two put options at a lower strike (e.g., at $660).
The Uncovered Risk: Since you bought one put and sold two puts, you have a naked short position on one contract (2 short - 1 long = 1 net short put). This net short put exposes you to unlimited risk if the stock price drops below the lower breakeven ($660).
SPY Example (1:2 Ratio)
We use the Dec 19th Expiry (39 days).
SPY Current Price: $680.30
Action: Buy 1 $670 Put for $9.326 (Long Leg)
Action: Sell 2 $660 Puts for $6.86 each (Short Legs)
Net Credit Received: $13.72 - $9.326 = $4.394 (or $439.40 total per 1:2 spread)
This creates a $670/$660 Put Ratio Spread for a $4.394 net credit.
3. Risk and Reward Profile (The Uncapped Risk)
Minimum Profit (If Stock Rallies)
The minimum profit occurs if the stock rallies above the higher strike ($670), causing all options to expire worthless.
Minimum Profit (Upside) = Net Credit Initially Received
SPY Example: Minimum Profit (Upside) = $4.394 or $439.40 per spread.
Trigger: SPY closes at or above $670 at expiration.
Maximum Profit (If Stock Falls to Lower Strike) 🏆
The maximum dollar profit occurs when the stock closes exactly at the lower strike ($660). At this price, the long put is at its maximum value, and the two short puts expire worthless.
Maximum Profit (At $660) = (Higher Strike - Lower Strike) + Net Credit
SPY Example:
Max Profit: $(\$670 - \$660) + \$4.394 = $14.394 (or $1,439.40 per spread)
Trigger: SPY closes exactly at $660 at expiration.
Maximum Risk (If Stock Falls Sharply) ⚠️
If SPY falls below the lower break-even point, the losses are uncapped due to the naked short put contract.
Loss Below Lower Break-Even = Uncapped
4. Break-Even Price
Break-Even = Lower Strike - Spread Width - Net Credit
SPY Example: $660 - $10 - $4.394 = $645.606
Why the Probability of Profit (PoP) is High
The primary appeal of opening the Ratio Put Spread for a net credit is the dramatically increased Probability of Profit (PoP), which is often 70-90% (our example has 87% PoP).
The Advantage of the Upper Break-Even
The spread is profitable if SPY closes above the Break-Even Price.
Break-Even Calculation: The Break-Even Price is $645.60
Profit Zone: Since the current SPY price is $680.30, the stock can fall over $34.70 (or 5.1%) and you still make a profit.
Selling Puts for Income: The substantial net credit received pushes your break-even point far below the lower strike, creating a large buffer zone where the stock can retreat significantly, and you still keep your money. This wide profitable range against a minor decline or bullish stability is what drives the high PoP, despite the uncapped risk if the stock falls too far.
5. The Greeks: Understanding Strategy Dynamics
Ratio Spreads are highly sensitive to market movement due to their unbalanced structure. Gamma is the most crucial Greek here—it is high and negative, meaning that as the stock falls toward your short strike, your negative Delta grows rapidly, increasing your risk exponentially. Theta is usually positive, but the uncapped Gamma/Delta risk far outweighs the small daily premium capture. This strategy demands constant monitoring.
Calculating Net Greeks
Net Delta: +0.190 (-0.364+0.277+0.277) - Slight initial bullish bias.
Net Gamma: -0.007 (0.011-0.009-0.009) - Leads to accelerating losses if the stock drops sharply.
Net Theta: +0.14(-0.134+0.137+0.137) Small profit from time decay.
6. Risk Warning: DO NOT USE AS A BEGINNER ⚠️
The Ratio Put Spread is highly complex and carries uncapped risk if the underlying asset moves sharply against the short leg (a sharp fall in price). This strategy is not suitable for non-professional or beginner traders.
7. Managing the Trade and Conclusion
Managing ratio spreads is about managing risk, not just profit. If the stock drops sharply and breaches the lower strike, you must act immediately to reduce the naked exposure by buying back the extra short put contract. Do not allow a ratio spread to reach expiration if the stock is below the lower strike, as your broker will assign you stock on the long put but leave you with an uncovered short put, leading to rapid, potentially catastrophic losses.
Actions at Expiry
SPY closes above the Upper Strike ($670): All options expire worthless. You keep the Minimum Profit (Net Credit). Nothing for you to do except enjoy the profits.
SPY closes below upper strike ($670) and above the Breakeven and lower strike ($660). The $670 strike will be ITM. You will sell the Long $670 leg for a profit. The $660 will expire worthless and you also keep the credit.
SPY closes below the Lower Break-Even ($645.61): You face uncapped loss.
Action: Before expiration, you can close the naked short put or roll it out and down to a lower strike. The remaining long $670 Leg and short $660 leg will cancel each other out.
💡 Course Summary and Next Steps
The Ratio Put Spread is an advanced, high-leverage strategy that carries the risk of uncapped loss. It is used to generate a credit while positioning for a strong directional move.
Key Takeaways
Definition: The Ratio Put Spread involves buying 1$put at a high strike and selling 2 puts at a lower strike.
Trade Example (SPY $670/$660, 1:2 Ratio):
Net Credit Received (Min Profit): $4.394 ($439.40 total).
Max Profit (At $660): $14.394 ($1,439.40 total).
Break-Even: $645.61
Risk: UNCAPPED below the lower break-even point.
Warning: This strategy has negative Gamma and is not suitable for beginners due to the presence of a naked option.
Actionable Next Steps
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📈 Ready for Defined Risk?
If you are a beginner, return to the defined-risk strategies. The Bear Put Spread offers similar directional exposure to a drop but with capped loss.
Ratio Put Spread: Actions to take at expiry
The action you take at expiry will depend on where the share price is trading at:
If the share price is above the long put strike price: Both put options will be out-the-money and worthless. The position will disappear on the next trading day. Simply enjoy the profits (if you placed the trade as a credit!). If you place it as a debit you will lose the debit paid.
If the share price is below the short puts strike price: Both the long and the short puts will be in-the-money and you may have a loss or a profit depending on where the share price is trading. If you do nothing you will end up buying the number of shares from the uncovered short puts. You have can do either of the following:
Let the entire position expire. The long put will partially cover the short put position. But you will take assignment of the shares from the uncovered put(s). You can then sell the shares later to close the long stock position. You would only do this if you were bullish on the stock.
Roll out the uncovered put for another month and generate more credit. The long put will offset the remaining puts. You will be left with a short put position for the new expiry. You would only do this if you were bullish on the stock.
Roll out the entire trade and generate more credit. Again, you would only do this if you were bullish on the stock.
Close-down the uncovered put.The long put will offset the remaining put. You will take the profit or loss on the entire trade depending on where the share price is trading.
The share price is between both strikes: This is a great position to be in as value is gaining on the long put side of the trade also. You have can do the following:
The short put(s) option will be out-the-money and has no value. But the long put option does have value. You can simply close the long put. This is a bonus for you in this trade if you placed it as a credit.
Let the trade expire. The short puts will expire worthless but you will be short the number of shares from the long put position that you have. Your broker will automatically sell the shares from the long put. The risk here is that if after expiry Friday the share price gaps up above the price you ‘shorted’ them at, the short stock position will be in a loss position. We don’t like taking this chance.
Close the entire trade together. This is not something we like to do as you are paying more trading commissions to close-down the short puts which are set to expire worthless.
Rollout the entire trade for a net credit again.
Placing and Managing a Ratio Put Spread with an Online Broker
How to place a Ratio Put Spread
Rolling out a Ratio Put Spread
Closing down the trade
Test Your Knowledge 1
CLICK HERE to take the quiz
Test your knowledge 2
At this stage it is best if you start practicing for real so this is what we want you to do:
Pick any option able stock that you have a mildly bearish/bullish outlook
Place a Ratio Put Spread 1:2 at a credit
Do a profit & Loss table
Place the trade in a 'Simulated' or 'Demo' account with an online broker
Identify your breakeven
Identify your Max Loss
Identify your Max Profit
Share your insights on our daily members web meetings
Review on Google
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