Target a Profit Zone in Microsoft Stock Between $350 and $390 with This Spread Trade
A put ratio spread is an advanced option trade and generally not suitable for beginners, but it can have its place within an option portfolio.
It is generally considered a neutral strategy, although it has the ability to make a profit in up, down and sideways markets.
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Yes, it can make money no matter which way the market goes, the key is the timing!
The strategy involves buying a number of put options and selling more put options further out-of-the-money.
The trade is placed when the trader thinks the underlying stock will be stable or slowly move lower and finish around the short put strike at expiry.
A fall in implied volatility will benefit the trade and it can also be profitable if the stock moves up early in the trade.
The big risk with the trade is a sharp move lower early in the trade.
Let’s look at an example using Microsoft (MSFT).
Microsoft Ratio Spread Example
Buying the April 17 put with a strike price of $390 for around $7.93 and selling 2 of the April 17, 370-strike puts for around $4.00 would create a put ratio spread.
As we are selling 2 contracts at $4.00 the trade results in a net credit of $0.07 which is $7 premium.
This is the maximum gain above a stock price of $390. Basically, all the puts would expire worthless and the trader keeps the $7 premium.
A tent-shaped profit zone exists between $350 and $390 with the maximum gain occurring at $370 and is around $2,000.
This is what the trade looks like as of today:
You can see the main risk in the trade is a drop in price early on. The blue line is the profit and loss at expiration and the purple line is the T+0 line. T+0 just means “today”.
So, we don’t want the stock to get into the profit tent too early.
What about in three week’ time? How does the trade look then?
Looking a lot better for any price above $365.
One advantage of this trade type is it takes advantage of option skew. Notice the contract we are buying has lower volatility (31.44%) than the contract we are selling (34.14%). Buy low, sell high.
Not that the trade starts with a delta of 3, which means the initial position is roughly equivalent to being long 3 shares of MSFT stock, although this will change as the trade progresses.