Understanding The Put Ratio Front Spread - Net Credit

Continuing our exploration of put spread strategies, we now turn to the Put Ratio Front Spread (Net Credit)—a strategic approach designed for traders who anticipate moderate bearish movements but want to ensure a limited risk structure. Let's examine how a fictional investor, Sarvani Shah, implements the Put Ratio Front Spread and why she prefers this net credit variant 

What is a Put Ratio Front Spread (Net Credit)?
The Put Ratio Front Spread is an options strategy that benefits from a controlled bearish outlook while collecting an upfront premium. It involves:

1. Buying one out-of-the-money (OTM) put option
2. Selling two lower-strike put options

Since sold puts generate more premiums than bought ones, the trader enters the trade with a net credit while controlling downside exposure.

Why Use the Put Ratio Front Spread (Net Credit)?
This strategy is ideal for traders who:
​​​​​​• ​Expect the market to decline moderately but not sharply.
• Want to collect an upfront credit in case the market stays sideways.
• Prefer a capped risk approach, where losses are limited beyond a certain point.

For Sarvani, this strategy aligns with her expectation that Nifty could experience a mild decline in the coming weeks.

Executing the Put Ratio Front Spread (Net Credit)
Here’s how Sarvani sets up her position:
• Nifty Current Market Price: 10,900
• Buy 1 Lot 10,900 PE @ ₹122
• Sell 2 Lots 10,800 PE @ ₹87 each
• Expiry Date: (Mentioned expiry date)

Net Credit Calculation:
• Premium received from selling two puts = 87 x 2 = ₹174
• Premium paid for buying one put = ₹122
• Net Credit: ₹52 (₹174 - ₹122)

Breakeven Points
The Put Ratio Front Spread (Net Credit) has two breakeven points:
1. Upper Breakeven Point (UBEP): Strike Price of Bought Put + Net Credit 10,900 + 52 = 10,952.
2. Lower Breakeven Point (LBEP): Strike Price of Sold Put - (Strike Price Difference - Net Credit) 10,800 - (100 - 52) = 10,572 Sarvani’s profit zone exists between 10,952 and 10,752, with limited loss potential beyond the lower breakeven point.

Payoff Structure
The payoff for the Put Ratio Front Spread (Net Credit) depends on where Nifty closes at expiry:

1. If Nifty remains above 10,952:
• All options expire worthless.
• Sarvani retains the net credit (₹52) as her profit. Profit: ₹52

2. If Nifty closes between 10,952 and 10,800:
• The bought put gains value.
• The sold puts lose value, but since two were sold, it impacts the overall payoff.
• Net payoff varies based on the exact expiry price.

3. If Nifty falls below 10,752:
• The maximum loss is capped as the loss from the two short puts exceeds the gain from the long put.
• Loss calculation depends on the market movement beyond this level.

Sarvani can achieve a maximum profit of ₹152 at the 10,800 level, whereas losses will begin below 10,600 and increase indefinitely as prices drop further.

Put Ratio Front Spread (Net Credit) vs. Put Ratio Back Spread (Net Credit)
Both strategies involve selling two puts and buying one, but their objectives and payoff structures differ:

1. Cost Structure: Upfront Credit:
• Put Ratio Front Spread (Net Credit): Yes.
• Put Ratio Back Spread (Net Credit): Yes.
Best Used When:
• Put Ratio Front Spread (Net Credit): Expecting a mild decline.
• Put Ratio Back Spread (Net Credit): Expecting a sharp fall.

2. Market Outlook:
• Put Ratio Front Spread (Net Credit): Best suited for a mildly bearish outlook.
• Put Ratio Back Spread (Net Credit): Designed for a strongly bearish outlook.

3. Profit Potential:
• Put Ratio Front Spread (Net Credit): Limited profit.
• Put Ratio Back Spread (Net Credit): Unlimited profit.

4. Risk Profile:
• Put Ratio Front Spread (Net Credit): Capped loss below LBEP.
• Put Ratio Back Spread (Net Credit): Capped loss above UBEP.

Sarvani had previously explored the Put Ratio Back Spread (Net Credit) for high-volatility markets. However, with Nifty showing signs of limited downside movement, she chose the Put Ratio Front Spread (Net Credit) to benefit from a controlled bearish setup.

Conclusion
The Put Ratio Front Spread (Net Credit) is a practical strategy for traders anticipating a slight bearish move but maintaining a risk-controlled structure. The upfront credit provides an immediate gain if the market remains range-bound, while potential losses are limited beyond a certain downside level. For traders like Sarvani, selecting the correct options strategy based on market conditions is essential. By implementing a structured approach, she continues refining her skills and effectively adapting to market fluctuations.