Explanation

Put backspread options strategy also known as reverse put ratio spread is a bearish options strategy that is executed when a trader holds a bearish outlook on the underlying asset but at the same time bullish on the volatility. Implementation of the strategy involves selling a number of put options and buying more put options of the same underlying asset with the same expiration date. The strategy gives chance for unlimited profit but at limited risk. The strategy is implemented only when the trader believes that the underlying asset will experience significant downside movement in the near term.

The setup of the strategy can be done in different ratios like 2:1, 3:2, etc, and it solely depends on the assumption and believes of the options trader.

Risk

The maximum loss would be incurred when the price of the underlying asset expires at the long put option. In that scenario, the short put will make losses, and the premium paid on the short put would go worthless.

Reward

If the trader’s assumption on the asset comes true then the maximum upside to the profit is unlimited.

Construction

Sell 1 ITM Put Option

Buy 2 OTM Put Options 

Payoff Chart

Option Trading Example

Suppose Nifty is trading at Rs. 16950 levels, the trader feels bearish on the market and bullish on volatility. He will execute Put Backspread Strategy where he will short 1 lot of 17150 in-the-money (ITM) Put Option at a premium of Rs. 185 & buy 2 lots of Nifty 16950 out-of-the-money (OTM) Put Options at a premium of Rs. 60 each. His account will be credited by Rs. 3250. [{185- (60*2)} *50].

Scenario 1: 

At expiry, if Nifty closes at Rs. 16600, in such a scenario the trader will make a profit.

Profit = Loss on short ITM put + gain on Long OTM put

15750 = (-17150 + 16500 + 185) + (16950 – 16500 – (60*2)) * 50

Scenario 2:

At expiry, if NIFTY closes at Rs. 17200, then Mr. X will get to keep his premium i.e. Rs. 3250