Structuring a Strong Bearish View

From Moderate to Strongly Bearish

The strategies covered earlier were designed for different degrees of bearishness.

• Bear Put Spread: Moderately bearish
• Bear Call Spread: Moderately bearish
• Put Ratio Back Spread: Strongly bearish

The difference is important.

If you expect the market to decline only moderately, a conventional bearish spread can be appropriate.

But if you expect a large downward move, a Put Ratio Back Spread can provide greater downside participation.

The strategy is essentially the bearish counterpart of the Call Ratio Back Spread discussed earlier.

The Basic Structure

The classic Put Ratio Back Spread uses:

• Sell 1 ITM Put
• Buy 2 OTM Puts

The ratio is therefore:

1 : 2

For every one Put sold, two Puts are purchased.

The strategy can also be scaled proportionally:

• Sell 2 ITM Puts + Buy 4 OTM Puts
• Sell 3 ITM Puts + Buy 6 OTM Puts

The important point is to maintain the 2:1 ratio between the long and short positions.

The options should generally have the:

• Same underlying
• Same expiry
• Same quantity ratio

Why Sell One Put and Buy Two?

At first, selling a Put when you are bearish may seem strange.

The reason is similar to the Call Ratio Back Spread.

The premium received from selling the ITM Put helps finance the purchase of two OTM Puts.

This creates greater downside exposure.

If the market falls sharply, both long Puts can gain substantial value.

If the market rises significantly, all the Puts can expire worthless, allowing the trader to retain the initial credit.

However, a moderate decline can create the strategy's loss zone.

So once again, the size of the move matters.

A Practical Example

Suppose:

• Nifty Spot = 7,800
• You expect Nifty to fall significantly towards 7,400.

This is a strongly bearish view.

You could construct the strategy by:

• Selling 1 ITM Put
• Buying 2 OTM Puts

For example:

Sell 7,900 PE

and

Buy 2 × 7,700 PE

The exact premium received and premiums paid determine the net credit or debit and the resulting payoff.

The important concept is the structure:

One Put sold against two lower-strike Puts bought.

Understanding the Payoff

The Put Ratio Back Spread has three broad outcome zones.

1. Market Rises

If the market rises above the short Put's strike, all three options can expire worthless.

The trader retains the initial net credit.

Therefore, the profit is limited.

2. Market Declines Moderately

This is the difficult zone.

The short ITM Put begins generating a liability as the market falls.

The two OTM Puts also gain value, but initially they may not gain enough to fully offset the loss on the short Put.

This creates a maximum loss zone.

3. Market Falls Sharply

This is where the strategy becomes attractive.

Both long OTM Puts gain value as the underlying declines.

Because you own two Puts against only one short Put, the additional downside exposure can generate substantial profits.

Since the underlying theoretically has no fixed lower limit above zero, a large decline can produce significant profit potential.

The strategy is therefore suited to traders expecting a major downward move.

Why the Profit Potential Can Become Very Large

Consider what happens during a sharp decline.

The short ITM Put loses value as the underlying falls.

But you own two lower-strike Puts.

Once the market moves sufficiently below the long Put strikes, both long Puts begin participating strongly in the decline.

The gains from the two long Puts can then outweigh the loss from the single short Put.

This creates the characteristic payoff of the Put Ratio Back Spread:

Strong fall → Increasing profit

The farther the underlying declines, the more valuable the two long Puts can become.

What Happens If the Market Rises?

Suppose the market unexpectedly moves higher.

All the Puts may expire worthless.

In that situation:

• The short Put expires worthless.
• Both long Puts expire worthless.
• The trader keeps the initial net credit, if the strategy was established for a credit.

Therefore, the upside-side profit is limited to the initial credit.

This is the opposite of the large downside profit potential.

The Important Middle Zone

The most important risk to understand is the moderate decline.

A trader might correctly predict:

"The market will fall."

But if the market falls only a little, the strategy may still lose money.

Why?

Because the short ITM Put becomes increasingly valuable as the market falls.

The two OTM Puts are also gaining value, but until the market moves sufficiently below their strikes, their combined gains may not fully offset the short Put's loss.

Therefore:

Correct direction does not automatically mean a profitable trade.

The expected magnitude of the decline is critical.

Maximum Profit on the Upside

If the underlying expires above the short Put strike, all the Puts can expire worthless.

The trader then retains the initial credit.

Therefore:

Maximum Profit on the Upside = Net Credit

This is a limited profit.

Maximum Loss

The strategy has a defined maximum loss in the middle range.

The exact maximum loss depends on:

• Strike selection
• Net credit or debit
• Distance between strikes

The general relationship is based on the difference between the short Put strike and the long Put strike, adjusted for the initial credit.

Therefore, maximum loss should always be calculated before entering the trade rather than assuming that the 2:1 structure automatically limits risk.

Breakeven Levels

The Put Ratio Back Spread can have two breakeven levels, depending on the exact strikes and premium structure.

This is similar to the payoff behaviour of the Call Ratio Back Spread.

The lower breakeven is particularly important because the market needs to fall sufficiently for the two long Puts to overcome the loss created by the short Put.

Once the market moves beyond the lower breakeven, the strategy can begin generating increasing profits.

Why the 2:1 Ratio Matters

The defining feature of the strategy is:

Buy 2 Puts for every 1 Put sold.

This creates greater downside exposure.

For example:

Sell 1 × 7,900 PE

Buy 2 × 7,700 PE

The two long Puts are what allow the strategy to benefit substantially from a sharp fall.

If you instead bought and sold the same number of Puts, you would be creating a conventional Put Spread rather than a Put Ratio Back Spread.

Put Ratio Back Spread vs Bear Put Spread

Both strategies can be bearish, but they are designed for different expectations.

The key distinction is the magnitude of the expected move.

When Is the Strategy Most Useful?

The Put Ratio Back Spread is most relevant when you expect:

• A significant downward move
• A sharp correction
• A major negative event
• A substantial breakdown from current levels

The strategy is therefore more directional than a standard Bear Put Spread.

You should have a stronger bearish conviction before using it.

Why Event-Based Situations Can Matter

Large price movements can occur around important events.

For example, a stock may be approaching:

• Quarterly results
• A major corporate announcement
• A regulatory development
• A significant technical breakdown

If you believe the event could result in a sharp decline, a Put Ratio Back Spread may be considered.

However, the strategy still needs careful strike and premium selection.

The existence of an event alone does not make the strategy automatically suitable.

Volatility Considerations

Volatility is particularly relevant for ratio back spreads because you are:

• Short one option
• Long two options

The long options provide greater exposure to changes in implied volatility.

When there is sufficient time remaining before expiry, an increase in volatility can generally be beneficial to a ratio back spread because the two long options can gain more value.

However, the exact impact depends on:

• Time to expiry
• Strike selection
• Current volatility
• Relative premiums

Therefore, volatility should be considered alongside the expected price move rather than in isolation.

The Core Logic

The Put Ratio Back Spread can be remembered through a simple sequence:

Strong bearish view

↓

Sell 1 higher-strike Put

↓

Buy 2 lower-strike Puts

↓

Use the premium received to help fund the long Puts

↓

Limited profit if market rises

↓

Loss possible if market falls moderately

↓

Substantial profit potential if market falls sharply

This is the central idea behind the strategy.

Key Takeaways

1. The Put Ratio Back Spread is designed for a strongly bearish market view.
2. It is the bearish counterpart of the Call Ratio Back Spread.
3. The classic structure is Sell 1 ITM Put + Buy 2 OTM Puts.
4. The strategy follows a 1:2 short-to-long ratio.
5. The premium received from the short Put helps finance the two long Puts.
6. If the market rises significantly, the strategy can retain a limited profit equal to the initial credit, if established for a credit.
7. A moderate decline can create a loss.
8. A sharp decline can produce substantial profit potential because two long Puts participate in the downside.
9. The magnitude of the expected move is as important as the direction.
10. Strike selection, premiums, volatility and time to expiry all influence the final payoff.
11. The strategy is better suited to a strong bearish conviction than to an ordinary moderate decline.
12. Before entering the position, always identify the maximum loss and breakeven levels based on the exact strikes and premiums selected.