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The following is the profit/loss graph at expiration for the Bear Put Spread in the example given on the previous page.

Break-even

The breakeven point for the bear put spread is given next:

Breakeven Stock Price = Purchased Put Option Strike Price - Net Premium Paid (Premium Paid - Premium Sold).

To illustrate, the trader purchased the $47.50 strike price put option for $0.44, but also sold the $45.00 strike price for $0.09, for a net premium paid of $0.35. The strike price paid was the $47.50. Therefore, $47.50 - $0.35 = $47.15. The trader will breakeven, excluding commissions/slippage, if the stock reaches $47.15 by expiration.
Max Profit

The max profit for a bear put spread is as follows:

Bear Put Spread Max Profit = Difference between put option strike price purchased and put option strike price sold - Premium Paid for bear put spread.

To illustrate, the put option strike price sold is $45.00 and the put option strike price purchased is $47.50; therefore, the difference is $250 [($47.50 - $45.00) x 100 shares/contract]. The net premium paid for the bull call spread is $35. Consequently, the max profit is $215 ($250 - $35). As a sidenote, this max profit occurs when the stock price is at $45.00 (the lower put strike price) or lower at expiration.
Partial Profit

Partial profit is calculated via the following, assuming the stock price is greater than the breakeven price:

For instance, the stock closed at $46.00 at expiration. Hence, the breakeven stock price ($47.15) minus the stock price at expiration ($46.00) would mean the trader profited $115 [($47.15 - $46.00) x 100 shares/contract]
Partial Loss

A partial loss occurs between the breakeven stock price and the upper purchased put strike price. The calculation is given next:

Bear Put Spread Partial Loss = Stock price - Breakeven price

For example, a closing stock price at expiration of $47.40 is between the upper put strike price of $47.50 and the breakeven of $47.15 and is therefore going to be a partial loss. When calculated, the loss is $25 [($47.40 - $47.15) x 100 shares/contract].
Complete Loss

A complete loss occurs anywhere above the upper purchased put strike price ($47.50) which amounts to the entire premium paid of $35.

The Bear Put Spread is liked by many traders more than simply buying a put option for two main reasons:

Reduces the capital spent/higher breakeven price.
Is a strategy than incorporates reality.

Lower Cost, Lower Breakeven Price

Because a bear put spread involves the selling of an option, the money required for the strategy is less than buying a put option outright. Moreover, the breakeven price is raised when implementing a bear put spread. To illustrate the cash outlay and breakeven prices for a bear put spread and just a put option are given next:

Bear Put Spread: cost $35; breakeven price $47.15
Put Option: cost $44; breakeven price $47.06

On a percentage basis, the bear put spread is over 20% cheaper than the cost of just purchasing a put. Realistic Expectations

The second advantage/disadvantage of a bear put spread is that this strategy considers the reality and probabilities of a potential move. Theoretically, the buying a put strategy has great profit potential. However, successful option traders generally focus on probabilities and take into consideration reality. A stock move from $50 to $45 is a 10% move. This has to occur in the time before expiration, in the example 30 days. In order for a rational options trader to buy just a put, the option trader has to expect a stock move lower that is greater than 10% within 30 days.

In conclusion, the bear put spread is a great alternative to simply buying a put outright: the bear put spread reduces the distance of the breakeven price and decreases the capital required to be bearish on a stock, it also is a strategy that takes into consideration realistic expectations.

A Bull Call Ratio Backspread is a bullish strategy and is potentially an alternative to simply buying call options. There are two components to the call ratio backspread:

Sell one (or two) at-the-money or out-of-the money calls
Buy two (or three) call options that are further away from the money than the call that was sold.

The ratio backspread is called such because there is a ratio of sold options to purchased option usually in the ratio of 1 sold to 2 purchased, or 2 sold to 3 purchased. A trader would use a Bull Call Ratio Backspread in the following hypothetical situation:

A trader is very bullish on a particular stock trading at $50.
The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply owning stock.
The trader expects the stock to move above $54.67 or not move at all or even fall in the next 30 days. However, a move higher to only $52.50 would prove disasterous for the trade.

Given those expectations, the trader selects the $52.50 call option strike price to buy two calls which are trading for $0.60 each so the total cost will be $120 (2 contracts x $0.60 x 100 shares/contract).

Also, the trader will sell one the at-the money call strike price at $50.00. By selling this call, the trader will receive $153 ($1.53 x 100 shares/contract). The net effect of this transaction is that the trader will receive $33 ($153 received - $120 paid).
Call Ratio Backspreads require Extreme Bullishness

For this trade, a trader must be extremely bullish on the stock. Only being slightly bullish will not work for this trade. One of the strange aspects of a bull call ratio backspread like the one in this example is that the greatest loss occurs in the direction the trader is hoping the trade will move (i.e. upwards).

The greatest loss occurs at the strike price of the purchased call options. The reason for this is that at $52.50, at expiration, the calls the trader purchased expire worthless ($120 loss). Meanwhile, the one call the trader sold has gained value and would be worth $250. The trader sold the call option for $153, so the sold call option has accrued a loss of $97 ($153 - $250). Combined with the loss suffered from the purchased options that expired worthless, the total loss is $217 ($120 + $97). The profit/loss graph on the next page illustrates this.

Once the stock price surpasses the strike price of the purchased calls (i.e. point of max loss), then the losses begin to decrease and eventually a profit occurs. This is because at the point of max loss, one call option that was purchased effectively begins to neutralize the option that was sold. One of the purchased option cancels out the movement of the one sold option. From there, the one remaining purchased option is free to begin to make a profit, just like if the trader only purchased a call option. In order to more clearly understand this past paragraph, the concept of delta must be understood.
Possible to make money if stock goes down

Yet another odd aspect of the bull call ratio backspread is that sometimes the trade will make money if the stock moves in the exact opposite direction the trader is expecting (i.e. downward). For instance, if the stock moves nowhere for 30 days and remains at $50.00, then the two calls the trader purchased would expire worthless ($120 loss). However, the one call the trader sold expired worthless also. Remember, the trader sold the option for $153; therefore, the trader actually gained on the transaction $33 ($153 gain - $120 loss).

The profit/loss graph for the bull call ratio backspread is given on the next page.

The following is the profit/loss graph at expiration for the Bull Call Ratio Backspread in the example given on the previous page.

Break-even

The breakeven point for the bull call ratio backspread is given next:

Breakeven Stock Price1 = Sold Call Option Strike Price + Net Premium Sold (Cost of Options Sold - Cost of Options Purchased). Note: This breakeven might not exist with every bull call ratio backspread a trader trades (i.e. if there is net premium purchased rather than sold).
Breakeven Stock Price2 = Sold Call Option Strike Price + 2 x Distance between strike prices of the call sold and the calls purchased - Net Premium Sold or + Net Premium Purchased.

To illustrate, the trader sold the $50.00 strike price call option for $1.53, and also bought two options at the $52.50 strike price for $0.60 each, for a net premium sold of $0.33 ($1.53 - $1.20). The strike price sold was the $50.00. Therefore, $50.00 + $0.33 = $50.33. The trader will breakeven, excluding commissions/slippage, if the stock is below $50.33 by expiration.

For the second breakeven, the distance between the two strike prices is $2.50 ($52.50 - $50.00). Consequently, 2 times $2.50 is $5.00. The net premium sold was $0.33. The sold call option strike price is $50.00. Summing everything together, $50.00 + $5.00 - $0.33 = $54.67. As such, the two breakeven points are $50.33 and $54.67.
Profit

The profit for a bull call ratio backspread is as follows:

Bull Call Ratio Backspread Profit = Stock price at expiration - Breakeven price

To continue the example, if the stock price at expiration is $56.00, then the profit would be $133 [($56.00 - $54.67) x 100 shares/contract].

To the downside, the max profit is $33 anywhere below the strike price of the option sold. This profit area to the downside might not exist for all bull call ratio backspreads.
Partial Loss

A partial loss occurs between the call strike price sold and the call strike price purchased. A partial loss also occurs between the point of max loss and the upper breakeven. The calculation is given next:

Bull Call Ratio Backspread Partial Loss1 = (Stock Price at Expiration - Strike Price of Option Sold) - Net Premium Sold or + Net Premium Purchased

For example, if the stock price was $52.00 at expiration and the strike price of the option sold is $50.00 and net premium sold was $0.33, then [($52.00 - $50.00) - $0.33] x 100 shares/contract = $167 loss.

Bull Call Ratio Backspread Partial Loss2 = (Upside Breakeven Stock Price - Stock Price at Expiration)

To illustrate, if the stock price at expiration was $54.00 and the upside breakeven stock price was $54.67, then [($54.67 - $54.00) x 100 shares/contract] = $67.
Max Loss

As stated previously, the max loss occurs at the strike price of the calls purchased. The formula is as follows:

Bull Call Ratio Backspread Max Loss = (Strike price of calls purchased - Strike price of call sold) + Net Premium Purchased or - Net Premium Sold.

As an example, the strike price of the calls purchased is $52.50, the strike price of the call sold is $50.00, and the net premium sold is $0.33: ($52.50 - $50.00) - $0.33 = $2.17 x 100 shares/contract = $217.

A Bear Put Ratio Backspread is a bearish strategy and is potentially an alternative to simply buying put options. There are two components to the put ratio backspread:

Sell one (or two) at-the-money or out-of-the money puts
Buy two (or three) put options that are further out-of-the money from the money than the put that was sold.

The ratio backspread is called such because there is a ratio of sold options to purchased option usually in the ratio of 1 sold to 2 purchased, or 2 sold to 3 purchased. A trader would use a Bear Put Ratio Backspread in the following hypothetical situation:

A trader is very bearish on a particular stock trading at $50.
The trader is either risk-averse, wanting to know before hand their maximum loss or wants greater leverage than simply owning stock.
The trader expects the stock to move below $45.46 or not move at all or even rise in the next 30 days. However, a move lower to only $47.50 would prove disasterous for the trade.

Given those expectations, the trader selects the $47.50 put option strike price to buy two puts which are trading for $0.44 each so the total cost will be $88 (2 contracts x $0.44 x 100 shares/contract).

Also, the trader will sell one the at-the money put strike price at $50.00. By selling this call, the trader will receive $134 ($1.34 x 100 shares/contract). The net effect of this transaction is that the trader will receive $33 ($134 received - $88 paid).
Put Ratio Backspreads require Extreme Bearishness

For this trade, a trader must be extremely bearish on the stock. Only being slightly bearish will not work for this trade. One of the strange aspects of a bear put ratio backspread like the one in this example is that the greatest loss occurs in the direction the trader is hoping the trade will move (i.e. downwards).

The greatest loss occurs at the strike price of the purchased put options. The reason for this is that at $47.50, at expiration, the puts the trader purchased expire worthless ($88 loss). Meanwhile, the one put the trader sold has gained value and would be worth $250. The trader sold the put option for $134, so the sold put option has accrued a loss of $116 ($134 - $250). Combined with the loss suffered from the purchased options that expired worthless, the total loss is $204 ($88 + $116). The profit/loss graph on the next page illustrates this.

Once the stock price falls below the strike price of the purchased puts (i.e. point of max loss), then the losses begin to decrease and eventually a profit occurs. This is because at the point of max loss, one put option that was purchased effectively begins to neutralize the option that was sold. One of the purchased options cancels out the movement of the one sold option. From there, the one remaining purchased option is free to begin to make a profit, just like if the trader only purchased a put option. In order to more clearly understand this past paragraph, the concept of delta must be understood.
Possible to make money if stock goes up

Yet another odd aspect of the bear put ratio backspread is that sometimes the trade will make money if the stock moves in the exact opposite direction the trader is expecting (i.e. upward). For instance, if the stock moves nowhere for 30 days and remains at $50.00, then the two puts the trader purchased would expire worthless ($88 loss). However, the one put the trader sold expired worthless also. Remember, the trader sold the option for $134; therefore, the trader actually gained on the transaction $46 ($134 gain - $88 loss).

The profit/loss graph for the bear put ratio backspread is given on the next page.

The following is the profit/loss graph at expiration for the Bear Put Ratio Backspread in the example given on the previous page.

Break-even

The breakeven point for the bear call ratio backspread is given next:

Breakeven Stock Price1 = Sold Call Option Strike Price - Net Premium Sold (Cost of Options Sold - Cost of Options Purchased). Note: This breakeven might not exist with every bear put ratio backspread a trader trades (i.e. if there is net premium purchased rather than sold).
Breakeven Stock Price2 = Sold Call Option Strike Price - 2 x Distance between strike prices of the call sold and the calls purchased + Net Premium Sold or - Net Premium Purchased.

To illustrate, the trader sold the $50.00 strike price put option for $1.34, and also bought two options at the $47.50 strike price for $0.44 each, for a net premium sold of $0.46 ($1.34 - $0.88). The strike price sold was the $50.00. Therefore, $50.00 - $0.46 = $49.54. The trader will breakeven, excluding commissions/slippage, if the stock is above $49.54 by expiration.

For the second breakeven, the distance between the two strike prices is $2.50 ($50.00 - $47.50). Consequently, 2 times $2.50 is $5.00. The net premium sold was $0.46. The sold put option strike price is $50.00. Summing everything together, $50.00 - $5.00 + $0.46 = $45.46. As such, the two breakeven points are $45.46 and $49.54.
Profit

The profit for a bear put ratio backspread is as follows:

Bear Put Ratio Backspread Profit = Breakeven price - Stock price at expiration

To continue the example, if the stock price at expiration is $44.00, then the profit would be $146 [($45.46 - $44.00) x 100 shares/contract].

To the upside, the max profit is $46 anywhere above the strike price of the option sold. This profit area to the upside might not exist for all bear put ratio backspreads.
Partial Loss

A partial loss occurs between the put strike price sold and the put strike price purchased. A partial loss also occurs between the point of max loss and the downside breakeven. The calculation is given next:

Bear Put Ratio Backspread Partial Loss1 = (Strike Price of Option Sold - Stock Price at Expiration) - Net Premium Sold or + Net Premium Purchased

For example, if the stock price was $48.00 at expiration and the strike price of the option sold is $50.00 and net premium sold was $0.46, then [($48.00 - $50.00) + $0.46] x 100 shares/contract = $154 loss.

Bear Put Ratio Backspread Partial Loss2 = (Downside Breakeven Stock Price - Stock Price at Expiration)

To illustrate, if the stock price at expiration was $47.00 and the downside breakeven stock price was $45.46, then [($45.46 - $47.00) x 100 shares/contract] = $154 loss.
Max Loss

As stated previously, the max loss occurs at the strike price of the puts purchased. The formula is as follows:

Bear Put Ratio Backspread Max Loss = (Strike price of put sold - Strike price of puts purchased) + Net Premium Purchased or - Net Premium Sold.

As an example, the strike price of the puts purchased is $47.50, the strike price of the put sold is $50.00, and the net premium sold is $0.46: ($50.00 - $47.50) - $0.46 = $2.04 x 100 shares/contract = $204.

An option whose strike price is near where the stock price is currently. For example, if the stock of XYZ is trading at $50.15, the $50 strike price for both puts and calls would be considered to be the at-the-money option strike price. An at-the-money option has little to no intrinsic value.
In-the-Money (ITM) Options

For calls, an option whose strike price is below where the stock price is currently. For example, if the stock of XYZ is trading at $50.34, the $45 strike price would be considered to be an in-the-money call option. An in-the-money call option is primarily made up of intrinsic value, with very little extrinsic value.

Note: Deep in-the-money refers to a strike price with basically all intrinsic value. In the example above, a strike price of $35 might be considered deep in-the-money because the strike price for the call is so far below the current stock price of XYZ.

For puts, an option whose strike price is above where the stock price is currently. For example, if the stock of XYZ is trading at $50.34, the $55 strike price would be considered to be an in-the-money put option. An in-the-money put option is primarily made up of intrinsic value, with very little extrinsic value.
Out-of-the-Money (OTM) Options

With calls, an option is out-of-the-money if the strike price is above where the stock price is currently. For example, if the stock of XYZ is trading at $49.87, the $55 strike price would be considered to be an out-of-the-money call option. An out-of-the-money call option is made up of entirely extrinsic value.

With puts, an option is out-of-the-money if the strike price is below where the stock price is currently. For example, if the stock of XYZ is trading at $50.34, the $45 strike price would be considered to be an out-of-the-money put option. An out-of-the-money put option is entirely extrinsic value.

The following option chain of the S&P 500 exchange traded fund (SPY) shows in-the-money, at-the-money, and out-of-the-money calls and puts:

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