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A Put Ratio Back Spread is an advanced options strategy used when you expect a significant fall in the price of a stock or index. It involves selling a smaller number of put options at a higher strike price and buying a larger number of puts at a lower strike price, usually in a 1:2 or 1:3 ratio.
This article explains what a put ratio back spread is, the formula, and how to calculate it.
Key Takeaways
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A Put Ratio Back Spread is designed to benefit from a sharp price fall.
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The strategy follows a 1:2 or 1:3 put ratio.
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It involves selling higher-strike puts and buying lower-strike puts.
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The strategy has limited but predefined risks that traders should understand.
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A payoff chart helps assess potential risks and returns before trading.
How to Build a Put Ratio Back Spread?
Traders use a put ratio back spread when they anticipate a sharp, aggressive downward move in an asset combined with a surge in market volatility. A Put Ratio Back Spread can be built by following these steps:
| Step 1 | Choose the Expiration Date | Select the same expiration date for all the put options based on how long you expect the stock or index to remain bearish. |
| Step 2 | Sell One Put | Sell to open 1 put option at a higher strike price to collect premium. This is usually an In-the-Money (ITM) put. |
| Step 3 | Buy Two Puts | Buy to open 2 put options at a lower strike price using the premium collected. These are usually Out-of-the-Money (OTM) puts, which create the 1:2 ratio. |
| Step 4 | Check the Net Cost | Execute the order for a net credit or a very small debit, depending on the difference between the selected strike prices and their premiums. |
Also Read About: What is OTM Call Options?
What is Put Ratio Backspread Formula
A Put Ratio Backspread is created by:
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Sell 1 put option at a higher strike price
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Buy 2 put options at a lower strike price
Formula
Put Ratio Backspread = Short 1 Put (Higher Strike) + Long 2 Puts (Lower Strike)
Example
Suppose a stock is trading at ₹100:
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Sell 1 put with a strike price of ₹100
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Buy 2 puts with a strike price of ₹90
Put Ratio Backspread = Short 1 ₹100 Put + Long 2 ₹90 Puts
The strategy can benefit from a sharp fall in the stock price, especially below the lower strike price.
Also Read About: Call Ratio Back Spread
Example of Put Ratio Back Spread
Suppose Nifty is trading at 7,506 and you expect it to fall sharply towards 7,000 by expiry.
Upper Breakeven: Because this trade is established for a net credit, you keep the premium if the market stays high. The upper breakeven occurs just below the short strike, calculated by subtracting the net credit from the short put strike:
Upper Breakeven = 7,500 - 42 = 7,458
If Nifty expires above 7,458, the position retains some or all of the net credit. If it drops below 7,458, the short put's intrinsic value starts exceeding your initial credit, pushing the trade into a loss.
Lower Breakeven: The lower breakeven point occurs below the long strikes, where the gains from holding two puts finally overcome the deep loss from the single short put. It is calculated by subtracting the maximum loss from the long put strike:
Lower Breakeven = 7,200 - 258 = 6,942
If Nifty falls past 6,942, the accelerating gains from holding two 7,200 puts fully overcome the losses from the short 7,500 put, driving the position into profitable territory.
Upper Breakeven: The upper breakeven occurs just below the short strike, calculated by subtracting the net credit from the short-put strike:
Upper Breakeven = 7,500 - 42 = 7,458
If Nifty expires above 7,458, the position retains some or all the net credit. If it drops below 7,458, the short put's intrinsic value starts exceeding your initial credit, pushing the trade into a loss.
Lower Breakeven: The lower breakeven point occurs below the long strikes, where the gains from holding two puts finally overcome the deep loss from the single short put. It is calculated by subtracting the maximum loss from the long-put strike:
Lower Breakeven = 7,200 - 258 = 6,942
If Nifty falls below 6,942, the accelerating gains from holding two 7,200 puts will fully offset the losses from the short 7,500 put, driving the position into profitable territory.
To understand how the strategy behaves at different Nifty levels, consider the following trade setup based on the available option premiums:
| Particulars | Action | Strike Price | Premium |
| Higher-strike Put | Sell 1 lot | 7,500 PE | ₹134 |
| Lower-strike Put | Buy 2 lots | 7,200 PE | ₹46 per lot |
| Total premium received | Total premium received | Total premium received | ₹134 |
| Total premium paid | Total premium paid | Total premium paid | ₹92 |
| Net Credit | Net Credit | Net Credit | ₹42 |
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Net Credit |
Net Credit |
Net Credit |
₹42 |
The trade, therefore, starts with a net credit of ₹42. The maximum loss occurs if Nifty expires at the lower strike of 7,200. The maximum loss is calculated as the difference between the strikes minus the net credit, giving ₹258 (₹300 − ₹42).
So what does this mean?
If Nifty remains above 7,500 at expiry, all three puts expire worthless, and the trader keeps the ₹42 net credit. If Nifty falls, the short 7,500 put starts losing value. At the same time, the two 7,200 puts begin to gain value as the Nifty moves below their strike price.
This shows that the strategy is designed for a significant fall, rather than a small decline. If Nifty falls far enough below the lower strike, the two purchased puts can generate increasingly higher profits.
The Payoff Chart
The payoff chart shows how the Put Ratio Back Spread performs at different Nifty levels on expiry.
The chart highlights the strategy's limited-risk, high-reward nature. The position starts with a ₹42 credit when Nifty remains above 7,500. As the Nifty falls towards 7,200, the loss increases, reaching its maximum at the lower strike. Below 7,200, the two purchased puts gain value faster than the sold put loses value, increasing the potential profit as the Nifty falls further.
Also Read About: What is Options Trading?
Effects of Option Greeks on Put Ratio Back Spread Strategy
Option Greeks help explain how the value of a Put Ratio Back Spread can change before expiry. Since the strategy combines one short put and two long puts, the overall effect of each Greek depends on the strikes and the position's distance from expiry.
Delta
A Put Ratio Back Spread has a negative delta, so it benefits when the stock or index falls. As the underlying moves lower, the two long puts can have a greater influence on the overall position, increasing its sensitivity to further declines.
Theta
Theta shows how time affects the strategy's value. As the expiry date gets closer, the options lose time value. If the expected sharp fall does not materialise, the Put Ratio Back Spread can lose value due to time decay.
Gamma
Gamma shows how quickly the strategy’s Delta changes when the stock or index moves. A Put Ratio Back Spread has positive Gamma, making it more sensitive to a fall in the underlying price. This can help the strategy become more profitable when the underlying stock or index falls sharply, especially if it drops below the lower strike price.
Also Read About: Option Greeks
Risk Management in Put Ratio Back Spread Strategy
A Put Ratio Back Spread has limited, predefined risk, so you should understand the potential loss before entering the trade.
- Understand the maximum loss: It occurs when the stock or index expires at the lower strike price. It is calculated as the difference between the two strike prices minus the net credit received.
- Watch the breakeven points: The strategy has two. If the stock or index expires between the lower and upper breakeven prices, the trade can result in a loss.
- Choose strike prices carefully: Traders should maintain the intended 1:2 ratio and consider the net premium before entering the position.
- Liquidity and execution impact: When executing a multi-leg options strategy like a put ratio back spread, always monitor market liquidity and bid-ask spreads. Thinly traded strikes or sudden spikes in market volatility can widen bid-ask spreads, causing execution slippage that eats into your net credit or increases your initial debit. Entering and exiting both legs simultaneously (or using limit orders) helps protect your planned pricing and prevents execution lag from turning a profitable spread into a loss.
- Consider volatility: Higher volatility can benefit the strategy when there is more time to expire. Its impact diminishes as expiry approaches.
Ideal Market Conditions for a Put Ratio Back Spread
- High Implied Volatility (IV): Deploy this strategy when market fear is elevated ahead of major macroeconomic events, elections, or corporate earnings, allowing you to sell overvalued near-term options and buy cheaper out-of-the-month options at favourable prices.
- Expectation of sharp, accelerated drops: Ideal when technical indicators or market sentiment point to a fast, aggressive breakdown through major support levels rather than a slow, grinding consolidation.
- Steep volatility skew: Works best when downside put options exhibit elevated skew, allowing the extra long puts to benefit heavily from expanding volatility as the underlying asset price drops.
Conclusion
The strategy may suit traders with a strong bearish view who expect a substantial price decline. A 1:2 or 1:3 ratio can yield different risk and reward profiles, so the position should be assessed carefully before execution. Drawing the pay-off chart can help you understand the possible outcomes.
