A Short Bear Ratio Spread, or sometimes known as a Short Ratio Bear Spread, a Short Put Ratio Spread or a Short Ratio Put Spread or a Put Back Spread,
is a cousin of the
Bear Ratio Spread. It is a bearish put option strategy which not only eliminates upfront payment, but also allows an unlimited profit potential,
something which the Bear Ratio Spread is unable to achieve.
The Short Bear Ratio Spread is made up of buying At The Money (ATM) or slightly Out Of The Money (OTM) put options and then selling to open
a lesser number of In The Money (ITM), more expensive put options of the same expiration month.
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Because In The Money (ITM) put options costs more than At The Money (ATM) or Out of the Money (OTM) put options, a lesser number of In The Money (ITM) put options is needed to cover or significantly reduce the cost of the ATM or OTM options while still gaining in value slower than the combined number of ATM or OTM options when the underlying stock falls.
Short Bear Ratio Spread Example
Assuming QQQQ at $44. Buy To Open 3 QQQQ Jan44Put @ $1.05, Sell To Open 1 QQQQ Jan47Put@ $3.15 covers the entire price of the long Put Options resulting in a zero upfront payment. |
The ratio of long and short put options depends largely on the preference of the individual trader. A common ratio is the 3 : 1 ratio spread where you sell to open 1 In The Money (ITM) put option for every 3 At The Money (ATM) or Out of the Money (OTM) put options that was bought.
The main deciding factor when determining what ratio
to establish the Short Bear Ratio Spread with is strike price. Here are the effects of different strike prices being used :
1. The wider the strike price difference between the short and Long Put Options, the less In The Money (ITM) put options you would need to
sell in order to cover the price of the Long Put Options but the further the lower breakeven point becomes.
2. The narrower the strike price difference between the short and Long Put Options, the higher the potential profit and the nearer the lower breakeven
point.
One should use a Short Bear Ratio Spread when one is confident in a strong fall in the underlying instrument and wishes to profit from that fall without any upfront payment and not lose any money should the stock rises .
The Short Bear Ratio Spread has an unlimited profit potential. It will keep making more profit as long as the underlying stock keep falling. The profitability of a short bear ratio spread can also be enhanced or better guaranteed by legging into the position properly.
A Level 3 options trading account that allows the execution of debit spreads is needed for the Short Bear Ratio Spread. Read more about Options Account Trading Levels.
Profit = ((long put strike - stock price) x number of Long Put Options) - ((short put strike - stock price) x number of short put options)
Profit Calculation of Short Bear Ratio Spread
Assuming QQQQ at $44. Buy To Open 3 QQQQ Jan44Put @ $1.05, Sell To Open 1 QQQQ Jan47Put@ $3.15. Assume QQQQ falls to $41. Profit = ((44 - 41) x 300) - (((47 - 41) x 100) = 900 - 600 = $300 profit. Because you paid nothing to put on this position, profit % is infinite. You made money out of nothing. |
Maximum loss = Total Premium Value Of Long Put Options - Total Premium Value Of Short put options
Profit Calculation of Short Bear Ratio Spread
Assuming QQQQ at $44. Buy To Open 3 QQQQ Jan44Put @ $1.05, Sell To Open 1 QQQQ Jan47Put@ $3.15. |
Upside Maximum Profit: Unlimited
Maximum Loss: limited
Maximum loss occurs when the underlying stock closes exactly at the strike price of the Long Put Options.
There are 2 breakeven points for a Short Bear Ratio Spread. The Lower Breakeven Point is point below which the position will start
to make a profit. The Upper Breakeven Point is the point above which the position will lose only the net debit (if any).
Lower Breakeven Point = Strike Price Of Long Put Options - (Maximum loss / (number of Long Put Options - number of short put options))
Profit Calculation of Short Bear Ratio Spread
Assuming QQQQ at $44. Buy To Open 3 QQQQ Jan44Put @ $1.05, Sell To Open 1 QQQQ Jan47Put@ $3.15. Net debit = 0, Maximum Loss = $300 Lower Breakeven Point = 44 - (300 / (300 - 100)) = 44 - 1.5 = $42.50 |
Upper Breakeven Point = Strike Price Of the Short put options.
Profit Calculation of Short Bear Ratio Spread
Assuming QQQQ at $44. Buy To Open 3 QQQQ Jan44Put @ $1.05, Sell To Open 1 QQQQ Jan47Put@ $3.15. Net debit = 0 Upper Breakeven Point = $47 If the stock rises above $47, the position will expire with zero profit / loss. |
As you noticed from above, the Short Bear Ratio Spread offers the best of both worlds as long as the underlying stock moves significantly up or down. |
:: No upfront payment needed for the position.
:: No loss occurs if the underlying stock rises drastically instead of falls.
:: Unlimited profit potential
:: Broker needs to allow the trading of credit spreads.
:: Makes less profit than a Long Put Option strategy on the same move in the underlying stock.
1. If the position is already in profit and the underlying stock is expected to continue it's drop, one could buy to close the
short put options, transforming the position into a Long Put Option
in order to maximise profits.
2. If the position is in profit and the underlying stock is expected to reach a certain price by expiration or stay stagnant at a certain lower price,
one could buy to close the short put options and then sell to open put options at the strike price which the underlying stock is expected to drop to. This
transforms the position into a Bear Put Spread.
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