Ratio Put Spread: Buy One Put, Sell Two

Key Takeaways

• A ratio put spread buys one put and sells two puts at a lower strike.
• Maximum profit occurs with the stock at the short strike at expiration.
• The extra short put is uncovered, so downside risk is large down to zero.
• The trade can often be opened for a small debit or even a credit.

What It Is

A ratio put spread, in its common 1x2 form, buys one put at a higher strike and sells two puts at a lower strike, all in the same expiration. The structure is a bear put spread plus one extra short put. That extra short put is uncovered, which creates the downside risk.

The view is market-neutral to mildly bearish. It is built for a stock that eases lower toward the short strike, not one that collapses.

The Intuition

Selling two puts pays for the one you buy, so the spread can be cheap or open for a credit. The premium from the second short put is compensation for taking on the risk of the stock falling well below the short strike.

The best outcome is the stock landing at the short strike at expiration. There, the long put captures the full decline to that point while both short puts expire worthless. Fall below the short strike and the naked put starts to hurt, with risk extending all the way to zero. Theta helps while price holds, since two short puts decay faster than one long put.

How a Ratio Put Spread Works

Buy 1 put at higher strike Kh, sell 2 puts at lower strike Kl, same expiration. The position can be a debit or a credit.

Net cost = long put premium - (2 x short put premium)   (negative = credit)
Strike width = Kh - Kl
Max profit = strike width + net credit, or strike width - net debit (at price = Kl)
Upper breakeven = Kh - net debit (debit case)
Lower breakeven = Kl - max profit
Max loss = large, down to (Kl - max profit) at a price of zero

If opened for a credit, there is no risk above the long strike, since the worst case there is keeping the credit. The exposure sits below the short strike, where the uncovered short put loses value as the stock falls toward zero.

P/L
 |            /\
 |           /  \          <- peak at short strike Kl
_|__________/____\_________ price
 |         /      \
 |  (loss)/        \  keep credit / small profit
   LB   Kl        Kh

Worked Example

Stock XYZ trades at 100. You buy the 100 put for 4.00 and sell two 90 puts for 2.00 each, collecting 4.00. The net cost is zero.

Net cost = 4.00 - (2 x 2.00) = 0 (even money)
Strike width = 100 - 90 = 10
Max profit = 10 + 0 = 10 (1,000 dollars) at price = 90
Lower breakeven = 90 - 10 = 80

If XYZ finishes at 90, the 100 put is worth 10.00 and both 90 puts expire worthless, for a 1,000 dollar gain. If XYZ finishes at or above 100, everything expires worthless and you break even (you paid nothing). Below 80, the naked short put drives losses, and at a price of zero the loss reaches 80.00 per share net. The downside is large but bounded by the stock reaching zero, unlike the unlimited upside risk of a ratio call spread.

Common Mistakes

1. Forgetting the naked put. The extra short put exposes you to the stock falling toward zero. A crash can produce a loss many times the credit collected.

2. Using it when you expect a crash. This profits from a gentle decline to the short strike. For a sharp drop, a put backspread or a long put is the better fit.

3. Underestimating margin. The uncovered short put ties up buying power and can trigger margin calls if the stock drops fast. Plan for that, not just the premium.

4. Ignoring assignment. A short put in the money can be assigned, leaving you long stock at the short strike unexpectedly.

5. Paying a large debit. A meaningful debit adds upside loss on top of the downside risk. The credit or even-money versions are usually cleaner.

Frequently Asked Questions

What is a ratio put spread in simple terms? A ratio put spread buys one put and sells two lower-strike puts, profiting if the stock drifts down to the short strike. The extra short put gives it large risk if the stock falls well below that strike.

How does a ratio put spread affect investment decisions? It expresses a mildly bearish view at low or no cost, suited to a stock expected to ease toward a target. Because the downside risk reaches to zero, sizing and a downside stop matter more than the entry cost.

What is a real-world example of a ratio put spread? Buying a 100 put and selling two 90 puts for even money gives a max profit of 1,000 dollars at 90 and a lower breakeven of 80. Below 80 the naked put drives losses.

How can investors use a ratio put spread effectively? Open it for a credit or even money to remove upside risk, set the short strike near a realistic downside target, and place a stop before the breakeven. Watching for assignment on an in-the-money short put avoids holding unwanted stock.

How is a ratio put spread different from a put backspread? A ratio put spread sells more puts than it buys, so it is short volatility with large downside risk. A put backspread buys more puts than it sells, making it long volatility with large downside profit instead.

Sources

1. Fidelity Learning Center. "1x2 Ratio Vertical Spread with Puts." https://www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/1x2-ratio-vertical-spread-puts
2. OIC (Options Industry Council). "Short Ratio Put Spread." https://www.optionseducation.org/strategies/all-strategies/short-ratio-put-spread
3. CME Group. "Option Ratio Spreads." https://www.cmegroup.com/education/courses/option-strategies/option-ratio-spreads
4. Charles Schwab. "Intro to Put Ratio Options Spreads." https://www.schwab.com/learn/story/intro-to-put-ratio-options-spreads

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.