A put ratio spread is an advanced option trade, but it can have its place within an option portfolio. If AMD stock stabilizes or bounces, here's how this strategy can profit.
Put Ratio Spread Setup
The put ratio strategy involves buying a put option and selling two put options further out-of-the-money. It's a bit more advanced because you do end up with an extra short put.
It is generally considered a slightly bullish strategy, although it has the ability to potentially make a profit in up, down and sideways markets. Yes, it can make money no matter which way the market goes — the key is the timing! Here's how it would work for Advanced Micro Devices.
We buy the Sept. 15 put with a strike price of 100 for around 1.75 and sell two of the Sept. 15 puts with a 95 strike for around 95 cents.
As we are selling two contracts for AMD stock, the trade results in a net credit of 15 cents.
The idea is that AMD stock will be stable and not drop below 95 at expiration.
A fall in implied volatility will benefit the trade and it can also be profitable if AMD stock moves up early in the trade.
The main risk with the trade is a sharp move lower early in the trade.
Managing The Options On AMD Stock
The trade is profitable above 89.85 at expiration. If AMD stock stays above 100 at expiration, all the puts expire worthless and the trader keeps the $15 premium. A finish exactly at 95 at expiration is the best-case scenario with a profit around $515. You keep the premium for the short puts plus you have a gain on your long put.
This strategy should move fairly slowly unless there is a sharp drop in AMD stock. The trade starts with a delta of 4, which means it is roughly equivalent to owning four shares of AMD stock, although this will change as the trade progresses.
According to the IBD Stock Checkup, AMD stock is ranked No. 7 in its group and has a Composite Rating of 91, an EPS Rating of 67 and a Relative Strength Rating of 94.
Downside Risk Similar To Stock
This trade is very similar to yesterday's Netflix broken wing butterfly. AMD stock just doesn't have a long put providing protection on the downside. Since the trade involves a naked option, it is not recommended for beginners.
In the unlikely case that AMD stock went to zero, you would be looking at a loss similar to owning the stock at 95, less the credit received.
Of course, you would use a stop loss. I would close the trade if it was down $200.
This short strangle on Intel can be closed early for a nice profit.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
