Ratio Put Spread

Ratio put spreads are for moderately bearish traders who believe the stock will decline TO a specific level but NOT crash beyond. The substantial downside risk is accepted because you believe it won't happen. If you think the stock might crash, use a regular put spread or long put.

Lower breakeven = Short Strike - (Max Profit / Number of Extra Short Puts). For example, if max profit is $5 and you have 1 extra short put, lower BE = Short Strike - $5. Below this point, the extra short put loses more than the spread gains.

If assigned on the extra short put, you're obligated to buy 100 shares at the short strike price. Your long put provides partial hedge. Most traders close before assignment becomes likely. If you can't afford the shares, you must close before expiration.

Put skew means OTM puts have higher IV than ATM puts due to demand for protection. This 'fear premium' means your short OTM puts collect proportionally more money, making it easier to achieve a credit on the ratio spread.

Substantial risk means the stock can fall to zero (100% loss on notional), while unlimited risk (calls) means no ceiling. Practically, stock crashes to zero are very rare for established companies, but 30-50% crashes do happen. Both require careful position sizing.

Compare IV at different strike deltas. Look at the 0.25 delta put IV versus ATM (0.50 delta) IV. If the 0.25 delta put has IV that's 5% or more higher in absolute terms (e.g., 35% vs 30%), skew is steep and ratio puts are attractive.

Roll lower if: the stock reaches the short strike but you believe support exists at a lower level, you can roll for a credit, and the new lower breakeven is acceptable. Don't roll just to avoid a loss - this can lead to larger losses.

As expiration approaches with short puts ITM, assignment becomes likely. Close before expiration if you don't want stock assignment. Early assignment is rare for equity puts (no dividend advantage) but close by 7 DTE to be safe.

Typically 30-45 DTE provides good balance. Shorter expirations have more gamma risk. Longer expirations tie up capital and have less theta benefit per day. Exception: if near-term skew is steeper, near-dated puts may offer better premium.

If the stock rallies well above the long strike, the position becomes a small loss (your debit) or small profit (if credit received). You can close to free capital, roll up to reposition at higher level, or hold if you still believe in moderate downside potential.

Screen for stocks with elevated put skew (25-delta IV > ATM IV by 5%+). Enter ratio put spreads on technically weak stocks approaching support. Time entries after volatility spikes when skew is steepest. Exit when profit target reached or skew normalizes.

It depends on your objective. For pure theta/vega exposure, delta hedge to zero. In practice, maintain slight negative delta (e.g., -10 to -20) to retain bearish exposure. Hedge more aggressively as stock approaches short strike where positive gamma increases.

Model scenarios at 20%, 30%, 50% market drops. Assume correlations spike to 0.9+ during crashes. Calculate aggregate portfolio loss if all ratio puts hit lower breakevens simultaneously. Ensure portfolio survives the March 2020 or 2008 scenario.

Convert to butterfly (add far OTM long put) when: profit is substantial and you want to lock it in, you expect continued decline but want to cap risk, or overnight gap risk is concerning. Cost of the wing is insurance premium for defined risk.

Variance risk premium (IV > RV) and put skew both benefit ratio put spreads. You're selling expensive puts (skew) that are likely to be overpriced (VRP). Track IV/RV ratios at your short strike - widest spreads indicate maximum edge. This double-edge makes ratio puts attractive in elevated IV environments.