Market crashes can be devastating for most traders, but with the right strategy, they can become profit opportunities. The put ratio backspread is designed to profit from significant downward moves while limiting your risk if you are wrong. In this guide, we will show you how this crash protection strategy works.
What is a Put Ratio Backspread?
A put ratio backspread involves selling one put option at a higher strike and buying multiple put options at a lower strike. The typical ratio is 1:2, meaning you sell one put and buy two. This creates a position with massive profit potential in a market crash but limited risk on the upside.
The simple version: You sell one higher-strike put and buy two lower-strike puts. If the market crashes, your two long puts generate massive profits. If the market rallies, you may even collect a small profit.
How to Construct a Put Ratio Backspread
The standard setup uses a 1:2 ratio:
- Sell 1 ITM or ATM put option
- Buy 2 OTM put options
- Same expiration date for all options
Example
Stock ABC is trading at $100. You are worried about a crash.
- Sell 1 $100 put for $6.00
- Buy 2 $90 puts for $2.50 each ($5.00 total)
- Net credit: $1.00 ($100)
If the stock crashes to $70, your two long puts print money.
Understanding the Payoff Profile
This strategy has an asymmetric payoff:
If the Stock Crashes to $70
- Short $100 put is worth $30 against you
- Two $90 puts are worth $20 each ($40 total)
- Net profit: $40 - $30 + $1 credit = $11 per share ($1,100)
If the Stock Stays at $100
- All options expire worthless
- You keep the $1 credit ($100 profit)
If the Stock Falls to $90 (Maximum Loss Point)
- Short $100 put is worth $10
- Long $90 puts expire worthless
- Net loss: $10 - $1 credit = $9 per share ($900)
If the Stock Rises to $110
- All options expire worthless
- You keep the $1 credit ($100 profit)
Calculating Breakeven Points
A put ratio backspread has two important price points:
- Upper breakeven: Sell strike - credit received = $100 - $1 = $99
- Lower breakeven: Long strike - (spread width + credit) / (long puts - short puts) = $90 - ($10 + $1) / 1 = $79
Below $79, you profit dollar-for-dollar on your extra long put.
Why Use a Put Ratio Backspread?
This strategy works best when:
- You expect a crash: Market conditions feel fragile
- Low implied volatility: Puts are cheap to buy
- You want limited upside risk: If wrong, you can still profit if the stock rises
- Portfolio hedge: Protect your long stock positions cheaply
The Power of Volatility Expansion
Put ratio backspreads benefit doubly from crashes:
- Intrinsic value gains: Your long puts move into the money
- Implied volatility spike: Fear causes put premiums to soar
- Combined effect: Profits can exceed what simple P/L math suggests
Volatility Impact Example
During a market panic, IV might jump from 20% to 50%:
- Your long puts gain value from both the price drop AND higher IV
- The short put gains too, but you have 2x the long exposure
- Net effect: Profits accelerate in panic conditions
Greeks and Position Management
Understanding the Greeks for this position:
- Delta: Net negative delta that becomes more negative as the stock falls
- Gamma: Positive gamma means accelerating profits in big moves
- Theta: Time decay hurts near the long strikes
- Vega: Strongly positive, meaning volatility spikes help you
Entering for Maximum Protection
You can structure the trade different ways:
Credit Entry (Recommended)
Receive money upfront. If the stock rallies, you keep the credit. You need a big crash to profit on the downside.
Even Money Entry
Pay nothing to enter. Break even if the stock stays flat or rises. Smaller downward move needed to profit.
Debit Entry
Pay money upfront. You need a downward move to break even. Maximum profit potential is highest.
Best Time to Use This Strategy
Consider put ratio backspreads when:
- VIX is low: Below 15-18 means puts are cheap
- Complacency is high: Markets have rallied without pullbacks
- Risks are underpriced: Geopolitical events, earnings, or economic data ahead
- Technicals show weakness: Distribution patterns or failed breakouts
Managing Your Position
Active management can improve outcomes:
- Stock crashing: Consider taking profits early, especially if IV spikes
- Stock rallying: Let it ride to collect the credit
- Near max loss zone: Roll down or out to avoid maximum pain
- Approaching expiration: Close or roll if still in the danger zone
Put Ratio Backspread vs Buying Puts
Comparing these bearish strategies:
- Cost: Backspread can be entered for a credit; long put costs premium
- If stock rallies: Backspread may profit; long put loses entire premium
- If stock crashes: Both profit, but backspread has unlimited potential
- Risk zone: Backspread has max loss in the middle; long put loses if stock is above strike
Common Mistakes to Avoid
- Using when expecting small drops: You need a significant crash to profit
- High IV environment: Paying expensive premiums reduces potential gains
- Too short expiration: Give yourself time for the crash to occur
- Ignoring the danger zone: Know where your max loss occurs
Visualize Your Risk
Pro Trader Dashboard displays P/L graphs for complex positions like ratio backspreads. See exactly where you profit and where you lose before placing the trade.
Summary
The put ratio backspread is a powerful strategy for traders who expect market crashes but want limited risk if wrong. By selling one higher-strike put and buying two lower-strike puts, you create unlimited downside profit potential. The key is entering when implied volatility is low and giving yourself enough time for the move to occur. This strategy works as both a speculation tool and a portfolio hedge.
Want to learn the bullish version? Check out our guide on call ratio backspreads or explore synthetic short stock for another bearish approach.