Selling More Than You Buy
It looks like a spread until the extra short leg runs out of cover. Find that point first.
Worth reading first: How Multiple Legs Become One Payoff, Why Selling an Option Is Not Just Buying in Reverse
Course catalogue99 lessons
A spread buys one contract and sells one. A ratio spread sells more than it buys. Two short for one long, or three for one.
It looks like a spread on the order ticket, it often opens for a credit where a spread would cost a debit, and past a certain price it stops being defined risk entirely. That transition is the whole lesson.
Watch the floor disappear
Start at a 1:1 ratio, an ordinary spread with a flat floor. Raise the short count and watch the left side of the payoff stop levelling off.
1 effectively naked below the short strike
Below $90.00 the long put is exhausted and 1 short contract are naked. The tent looks comfortable and the left side falls away with no floor.
Where the protection runs out
The long put covers exactly one of the short puts. Any additional short contracts are uncovered below the short strike.
Uncovered contracts = short quantity − long quantityThe count that determines whether this is a spread or something else.
At 1:1 the position is a vertical spread with a known maximum loss. At 2:1 one contract is naked below the short strike. At 3:1, two are. The payoff diagram shows it plainly once you know to look: a spread's left side goes flat, a ratio spread's keeps falling.
| Stock at expiration | Result | Note |
|---|---|---|
| $100 | +$60 | Everything expires |
| $95 | +$60 | Long put at the money |
| $90 | +$560 | Peak. The tent's apex |
| $84.40 | $0 | Breakeven on the way down |
| $70 | −$1,440 | One naked put, still falling |
| $40 | −$4,440 | No floor |
Long one $95 put, short two $90 puts, opened for a $60 credit.
The peak at $90 is genuinely attractive and it is what sells the structure. The bottom two rows are what the credit is paying for.
Why anyone trades them
They can open for a credit. Selling two puts funds the one you buy and leaves change. A position that pays you to enter and has a wide profitable band is genuinely appealing.
The peak is well placed. If you think a stock drifts down modestly, the maximum profit sits exactly there. Better than a plain credit spread, which just pays its credit.
Repair. A call ratio spread is sometimes used to improve a position that has moved against you, at the cost of adding uncovered upside risk.
The honest assessment
A ratio spread is a naked option with a partial hedge attached, presented as a spread. That framing is not unfair. It is what the position is.
For a retail premium seller the specific problem is that it fails the test the rest of this course applies: your position size should be set by the maximum loss, and here the maximum loss is unbounded on one side. There is no size at which the tail is acceptable except a very small one, and at a very small size the credit is not worth the complexity.
If you want the wide profitable band with a floor, an iron condor gives you that and keeps both wings.
If you trade one anyway
Put side only, on a stock you would own. The uncovered leg is then an obligation to buy shares. Bad, but bounded by the stock reaching zero. The call side is genuinely unlimited.
Size on the uncovered contracts. A 2:1 with one contract long is one naked put, and should be sized as one naked put.
Have an exit before the tent. The loss accelerates past the short strike and there is no natural stopping point to wait for.
What can go wrong
Reading the tent and not the tail. The chart's comfortable region is where attention goes.
Sizing it like a spread. It is not one past the short strike.
Trading the call side. Unlimited rather than large.
Using it to repair a loser. Adds uncovered risk to a position already going wrong.
Key takeaways
- A ratio spread sells more contracts than it buys; the excess is uncovered past the short strike.
- It opens for a credit and has a well-placed profit peak, which is what makes it appealing.
- Past the short strike the payoff has no floor. It is a naked option with a partial hedge.
- It fails the sizing rule this course uses: position size should follow the maximum loss, and here there isn't one.
- An iron condor gives a similar wide profitable band while keeping both wings.
Check your understanding
1. You are long one $95 put and short two $90 puts. How many contracts are uncovered below $90?
2. Why does a ratio spread's payoff chart mislead?
3. If you want a wide profitable band with a defined floor, what should you use instead?
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