Options Trading Made Easy: Ratio Put Write

Options Options Trading
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The ratio put write strategy is designed for traders with an existing short position in a stock who foresee a period of low volatility on the horizon. Rather than closing out their short sale and resetting it again later when the stock resumes its fall, the ratio put write allows them to profit in the interim.ratio put write
The trade’s risk/reward profile is similar to that of the ratio call write but, all told, it’s less advantageous for two reasons:

  1. The ratio call writer can collect dividends, while the ratio put writer must pay them; and
  2. Premiums written on call options are generally superior to those written on put options.

That said, let’s look now at the components of the strategy and then turn to a real-life trading example to see how it works.

Setting It Up

The ratio put write consists of two components:

  1. A short position in the underlying of, say, 100 shares; and
  2. Two or more short at-the-money puts (the number of puts representing a greater number than the number of shares shorted).

The strategy is best suited for a trader with a slightly bullish bias on the underlying, as losses will mount much quicker should the stock break strongly lower before expiry.

Nerves of Steel

Here’s a chart of U.S. Steel (NYSE: X) for a period dominated by a sideways drift in the share price:
X ratio put write
Let’s imagine you foresaw the drop in U.S. Steel and shorted the company in January. By the time mid-February rolled around you were up some 20%, but your research indicated the decline was likely over for the time being, and the stock would probably consolidate for the next few months.
Rather than buy back the shares and reset the short sale later, you decide it’s more prudent to seek other means of generating cash.
You discuss it with your broker and decide to initiate a ratio put write strategy, by which you’re able to gain some premium in the interim and likewise avoid sitting on a non-producing asset.
With the shares at $25, you sell two at-the-money June 25 puts for $3 each. Your credit is $600.

Bump and Grind

And it works!
U.S. Steel trades in a range between $22.50 and $28.50 for the next four months and closes at precisely $25.50 by expiry (blue circle). Your two short puts close worthless out of the money, and your shares suffer a minor $0.50 setback, leaving you with a profit of $550 ($600 [initial premium] – $50 [loss on the short sale]).
Your short sale is still in force as well, leaving you well positioned to capitalize on any further meltdown in the price of the shares.
But what if it had been otherwise?
Ratio put writes have two break-even points, one higher than the strike of the options and one lower. Every trade will produce different break-even parameters, depending on the number of options written and the strikes selected.
In the above example, losses are secured on the downside when the premium collected and gain on the short sale are overtaken by losses from the two short puts. In our example, that occurs at $19 ($600 [premium] + $600 [gain on short sale] – $1,200 [loss from two short puts]).
On the upside, gains are capped when losses on the short sale eat up the initial premium. In this case, it’s when U.S. Steel reaches $31.
In both cases, losses are theoretically unlimited beyond break-even.
Always monitor your trades!

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in The Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.

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