Introduction
The Put Ratio Spread is an advanced options trading strategy designed for traders who anticipate a moderate decline in the underlying stock or index while keeping the cost of the trade low. This strategy offers a balance between risk and reward by combining long put options with short put options in a higher ratio.
Put Ratio Spreads work best in low-volatility markets where traders expect a steady downside move without extreme fluctuations. This strategy is often structured as a near-zero-cost or small-credit trade, making it attractive for traders looking to optimize risk-reward dynamics.
In this blog, we will explore how the Put Ratio Spread strategy works, its risk-reward characteristics, and how to execute it efficiently using Algomojo.
What is a Put Ratio Spread?
A Put Ratio Spread consists of:
✔ Buying a smaller number of at-the-money (ATM) or in-the-money (ITM) put options (higher premium paid)
✔ Selling a larger number of out-of-the-money (OTM) put options (lower premium collected)
This structure helps reduce the overall cost of the trade and can sometimes generate a net credit, making it a cost-efficient bearish strategy.
Structure of a Put Ratio Spread
The strategy consists of two trades:
1️⃣ Buy 1 ATM or ITM Put Option (Long Leg)
2️⃣ Sell 2 OTM Put Options (Short Legs)
This creates a directional trade that benefits from moderate downward movements while having a defined risk on the upside.
Example of a Put Ratio Spread
Assume Stock XYZ is trading at ₹1000. You execute the following trades:
- Buy 1 ATM Put (Strike Price: ₹1000) at ₹50
- Sell 2 OTM Puts (Strike Price: ₹950) at ₹25 each
📌 Net premium paid: ₹50 – (₹25 × 2) = ₹0 (Zero Cost Trade!)
Possible Outcome Scenarios:
| Stock Price at Expiry | Profit/Loss | Explanation |
|---|---|---|
| ₹1000 (No Move) | Small loss | Time decay affects the long put. |
| ₹950 (Moderate Move) | Maximum Profit | The short puts expire worthless while the long put gains value. |
| ₹900 or Below (Strong Move) | Unlimited Loss | Losses increase as short puts become deep ITM. |
Key Takeaways
✅ Limited Risk – Maximum loss occurs beyond the breakeven point.
✅ Limited Profit – Best profit occurs at the sold strike price.
✅ Volatility Considerations – Works best in low-volatility environments.
✅ Cost-Efficient – Can be structured as a near-zero-cost trade.
Payoff Structure of a Put Ratio Spread
| Scenario | Impact |
| Price remains stagnant | ❌ Small loss due to time decay |
| Price moves down moderately | ✅ Maximum profit potential |
| Price drops significantly | ❌ Unlimited loss (if unhedged) |
| Volatility increases | ❌ Can increase losses |
| Volatility decreases | ✅ Beneficial since short options lose value |
Advantages of a Put Ratio Spread
📉 Cost-Effective – Reduces the net premium paid or even generates a small credit.
📈 Limited Risk (Up to Breakeven) – If the stock moves slightly downward, it is a profitable trade.
⚡ Works in Low Volatility – Unlike the Put Backspread, this strategy is best suited for low volatility markets.
💰 Customizable Strategy – You can modify the ratio (e.g., 1:3 or 2:3) to fit market conditions.
Risks and Considerations
❌ Unlimited Loss Beyond Breakeven – If the stock price falls too much, the short puts create large losses.
❌ Limited Profit Potential – The best profit occurs at the short put strike, after which profits diminish.
❌ Margin Requirements – Requires higher margin compared to simple spreads due to uncovered short puts.
Step-by-Step Implementation in Algomojo
With Algomojo, traders can seamlessly execute Put Ratio Spread strategies using automated order placement and execution.
1. Create a Buy ATM Put for Long Leg (Leg 1)
📍 Path: My Strategy → New Strategy
✔ Choose a near-the-money strike price.
✔ Select the ATM or ITM put option with the correct expiration.
✔ Verify lot size and margin requirements.
2. Create a Sell 2 OTM Puts for Short Leg (Leg 2)
📍 Path: My Strategy → New Strategy
✔ Choose a lower strike price than the long put.
✔ Sell 2 OTM put options.
✔ Ensure correct lot size and margin allocation.
3. Group the Strategy
📍 Path: My Group Strategy → New Group Strategy
✔ Combine both legs into a single Put Ratio Spread.
✔ Name the strategy for easy identification.
4. Enable Paper Trade Mode
📍 Path: My Group Strategy
✔ Test the strategy before deploying it in live markets.
✔ Simulate market conditions to observe behavior.
5. Generate a SELL Signal
📍 Path: My Group Strategy
✔ Click SELL to place both orders simultaneously.
6. Executed Paper Trade Orders
📍 Path: My Group Signals → Orders
✔ Verify that both legs are successfully placed in the Order Book.
✔ Ensure all contracts are filled at the intended strike and expiration.
7. Monitor Open Positions
📍 Path: My Group Signals → Positions
✔ Track price movements and implied volatility (IV) changes.
✔ Monitor the time decay (Theta) effect.
8. Generate a BUY Signal to Exit the Trade
📍 Path: My Group Strategy
✔ Exit the position if the stock reaches the desired profit target.
✔ Close the trade before expiration to capture gains.
9. Confirm Closing Orders
📍 Path: My Group Signals → Orders
✔ Ensure both legs are exited at the intended price.
✔ Validate the final PnL impact.
10. Review Trade Performance
📍 Path: My Group Signals → Positions
✔ Analyze profit/loss metrics.
✔ Optimize future Put Ratio Spread strategies based on insights.
Frequently Asked Questions (FAQ)
1️⃣ How is a Put Ratio Spread different from a Put Backspread?
📌 Put Ratio Spread: Limited profit and unlimited risk on downside.
📌 Put Backspread: Unlimited profit and limited risk.
2️⃣ What happens if the stock moves sideways?
📌 A small loss occurs due to time decay.
3️⃣ Can I execute a Put Ratio Spread with ITM options?
📌 Yes, but OTM options provide higher leverage.
4️⃣ Is this strategy suitable for high volatility markets?
📌 No, Put Ratio Spreads work best in low volatility environments.
Final Thoughts
The Put Ratio Spread Strategy is an excellent choice for traders looking to capitalize on a moderate bearish move while keeping costs low and risks manageable.
By using Algomojo, traders can efficiently execute, monitor, and refine this strategy with automated multi-leg execution and real-time tracking.
💡 Have you tried a Put Ratio Spread before? Share your experience in the comments! 🚀🔥