Put Ratio Spread is a neutral to a bullish strategy with no upside risk. It is doing by selling a far OTM put option to Long Put Vertical Spread. It is also known as the 1PE2PE Strategy.
- Buy ATM/OTM Put Option – 1 Lot
- Sell Far OTM Put Options – 2 Lots
Ideal IV Environment: High
Maximum Profit: Distance between the strikes + Credit received
How to Calculate Breakeven(s):
- Upside: Short Call Strike + Maximum Profit Potential ( i.e. Maximum Profit/Lot Size)
- Downside: None
Here goes an example – https://unofficed.com/options-calculator/?save_id=5dde7de893a98660557422
- Short 31700PE at 42 – 2 Lot
- Buy 31800PE at 71 – 1 Lot
- Although It sounds confusing, traders use different combinations of nomenclature. So, Front Ratio Call Spread or Call Ratio Front Spread means the same thing.
- Call Ratio Front Spread behaves like a short straddle when it comes to the movement in payoff graphs when the impact of Theta is negligible like when DTE (Date to Expiry) is far.
- Similarly, Call Ratio Back Spread behaves like a long straddle.
- The highest profit happens when there is a movement towards the maximum profit zone near the expiry. But, if there is a significant movement when DTE is far i.e. Theta’s impact is negligible, a Call Ratio Front Spread will do almost similar damage like a short straddle. We will discuss that later with payoff graphs.
The points discussed above are also applicable to the Put Ratio Spreads.
In Short, the Ratio Spreads mimic Straddles but limits the risk or the reward in one direction.