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Cl,apter 24: Ratio Spreads Using Puts 359
expire worthless and the result would be a loss of commissions. However, there is
downside risk. If XYZ should fall by a great deal, one would have to pay much more
to buy back the two short puts than he would receive from selling out the one long
put. The maximum profit would be realized if XYZ were at 45 at expiration, since the
short puts would expire worthless, but the long January 50 put would be worth 5
points and could be sold at that price. Table 24-1 and Figure 24-1 summarize the
position. Note that there is a range within which the position is profitable - 40 to 50
in this example. If XYZ is above 40 and below 50 at January expiration, there will be
some profit, before commissions, from the spread. Below 40 at expiration, losses will
be generated and, although these losses are limited by the fact that a stock cannot
decline in price below zero, these losses could become very large. There is no upside
risk, however, as was pointed out earlier. The following formulae summarize the sit­
uation for any put ratio spread:
Maximum upside risk
Maximum profit
potential
= Net debit of spread (no upside risk if done for
a credit)
= Striking price differential x Number of long
puts - Net debit (or plus net credit)
Downside break-even price = Lower strike price - Maximum profit potential +
Number of naked puts
The investment required for the put ratio spread consists of the collateral
requirement necessary for a naked put, plus or minus the credit or debit of the entire
position. Since the collateral requirement for a naked option is 20% of the stock
TABLE 24-1.
Ratio put spread.
XYZ Price at Long January 50 Short 2 January 45 Total
Expiration Put Profit Put Profit Profit
20 +$2,600 -$4,600 -$2,000
30 + 1,600 - 2,600 - 1,000
40 + 600 600 0
42 + 400 200 + 200
45 + 100 + 400 + 500
48 200 + 400 + 200
50 400 + 400 0
60 400 + 400 0