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Part(1)

Long ratio put spread versus call strategy for ABC company

Current market price:$639, view: moderately bearish

Buy 2 February 630 Puts@ 35.00

Sell 1 February 660 Put@ 52.00

Sell 2 February 690 Calls@ 13.00

Net credit:$8

Breakeven 1: $608

Breakeven 2: $652

Breakeven 3: $694

Graph of the payoff profile of this strategy is given below:

Ratio put spread and call payoff

Below $608 : Unlimited profit potential

Between $608 to $652 : Loss (maximum loss of $22 at $630 level)

Between $652 to $694: Profit(maximum profit of $8 between $660 and $690)

Above $694: Unlimited Loss potential

Part(2)

Now if we analyze the above strategy with option strategy analyzer, let us see what we get

630

607

661

689

695

Now you will notice that maximum profits and losses figures given in Part(1) do not match with the profits and losses figures given by the option strategy analyzer at different price levels of stock of ABC company. Why?

In my opinion, Option strategy analyzer considers the squaring off the option trades at the time of expiration while Option strategy given in Part(1) considers exercising of the options at those breakeven points at the time of expiration. Is that correct?

Now, which action is profitable 1)to square off the option trade or 2)exercise the option by you or counter-party at the expiry of 30 days time period as the case may be.

2
  • Your graph is not correct - below 630 the puts cancel each other out and the profit will be the total net premium collected.
    – D Stanley
    Feb 1 at 13:04
  • @D Stanley - The puts do not cancel each other out because it is a ratio put spread (he bought two $$630 puts and sold one $$660 put). Therefore, he is net long one put which on an expiration basis profits below $608 Feb 1 at 14:31

1 Answer 1

1

There is one small misstatement in your conclusion. On an expiration basis, your position makes money below $608 due to being net long one put. It is not unlimited since the lower bound is $0. Other than that, your analysis is spot on. Therefore, I did not look at the results from the Option Strategy Analyzer.

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