Ratio Put Spread

Ratio put spreads offer benefits that defined-risk strategies don't: potential to enter for zero cost or credit, higher max profit than standard spreads, and profit from IV contraction. The put skew also helps premium collection. However, they're only appropriate when you have high conviction the stock will NOT crash below the lower breakeven. Most traders should use butterflies instead.

Not technically - a stock can only fall to zero, so downside risk is 'substantial' but capped at Lower BE × 100 per naked put. However, on a A$50 stock, that could still mean A$3,500+ loss per contract. For practical purposes, treat it as severe risk that requires the same respect as unlimited risk.

Unlike ratio call spreads (truly unlimited), ratio put spreads have a theoretical floor (stock at zero). However, on high-priced stocks, losses can still exceed account equity in gap scenarios. Your broker will margin the position and issue margin calls, but overnight gaps can create losses before intervention.

Put skew means OTM puts have higher implied volatility than ATM puts (fear premium). When you sell OTM puts in a ratio spread, you're selling this expensive fear premium. This makes it easier to achieve credit entries compared to ratio call spreads where you're selling relatively cheap OTM calls.

Lower Breakeven = Short Strike - Max Profit per share. Max profit = Spread width + Net credit (or - Net debit). Example: Long A$36p, Short 2x A$32p for A$0.40 credit. Max profit = A$4 + A$0.40 = A$4.40. Lower BE = A$32 - A$4.40 = A$27.60.

1:2 ratio has higher profit potential per contract but more naked exposure (1 naked per 1 long). 2:3 ratio has lower profit per contract but less proportional naked exposure (1 naked per 2 longs). Choose 2:3 for slightly more conservative positioning. Choose 1:2 for maximum profit when you have very high conviction in the support level.

Assignment is most likely when: 1) Short puts are deep ITM, 2) Near expiration with little time value remaining, 3) Near ex-dividend date (holders may exercise to capture dividend). If assigned, you must buy 100 shares per contract at the strike price. Ensure you have capital available.

This is the nightmare scenario. If it gaps below your lower breakeven, you face immediate significant loss. Action depends on magnitude: Small gap below short strike - evaluate if support will reassert. Large gap well below lower BE - close immediately, even at significant loss. Hoping for recovery with substantial risk is dangerous.

To convert, buy back one of your short puts. Original: Long 1x A$36p, Short 2x A$32p. After buyback: Long 1x A$36p, Short 1x A$32p. This is a standard bear put spread with defined risk. Cost = buyback price. You sacrifice potential profit below the short strike but eliminate substantial downside risk.

Ratio put spreads outperform when: 1) Stock declines exactly to the short strike, 2) IV contracts after entry, 3) You can establish for credit. Bear put spreads outperform when: 1) Stock crashes well below short strike, 2) IV rises after entry. If you're uncertain about downside, bear put spread is safer.

Analyze IV at each strike. Put skew means lower strikes have higher IV. Look for strikes where IV is even higher than typical skew (rich puts). Sell strikes that are 'rich' vs theoretical value. Track skew percentile - sell when skew is steeper than normal (elevated fear). This improves credit and EV.

Track delta continuously. When delta turns positive and exceeds +0.30-0.40, consider shorting shares to neutralize. Unlike ratio call spreads where you buy shares to hedge, here you short shares. Key decision: If spread still has value near short strike, hedge. If spread is nearly worthless, close naked put directly.

Model all underlyings crashing simultaneously (correlation → 1 in crashes). Calculate total naked put exposure at -15%, -20%, -25% moves. Ensure total loss at -20% across all positions is survivable. Avoid concentration in correlated sectors. Track aggregate portfolio delta at various price levels.

Key parameters: 1) IV Rank >45% at entry, 2) Short strike at verified support, 3) Exit at 50% profit (not hold to expiry), 4) Exclude trades with earnings within DTE, 5) Elevated put skew (>normal percentile). The put skew filter alone adds ~2-3% EV by selling when fear premium is highest.

Crashes are typically faster and more violent than rallies ('stairs up, elevator down'). This means ratio put spreads can hit lower breakeven faster than ratio call spreads hit upper breakeven. However, put skew also steepens during crashes, potentially allowing profitable exit via skew gain. Monitor skew dynamics during stress.