Limiting Downside Exposure with a Put Ratio Backspread Strategy

Nifty Breaks Key Level, Traders Miss Opportunity

Key Figures:

• 25,360: The level that Nifty finally closed below, indicating a sharp fall.
• Rs 203: The net premium paid for Example 1 of the Put Ratio Backspread strategy.
• Rs 51: The net premium paid for Example 2 of the Put Ratio Backspread strategy.

Market Analysis

Read also: Treasury Yields Experience Largest Increase in Two Weeks Following Release of Labor Market Data

Last Friday, the Nifty index finally closed below 25,360, a level that had been defended for days. The sharp fall was fueled by escalating tensions between Israel, the US, and Iran. However, most traders missed the opportunity to profit from the move, as they were left hesitant due to the psychological damage inflicted by previous false breaks during the consolidation phase.

Understanding Consolidation

During consolidation, markets make sharp, choppy moves, making it difficult for traders to anticipate the next move. In the case of Nifty, the market was flirting with 25,360 for weeks, bouncing sharply back to 25,700 every time a breakdown seemed imminent. This led to traders getting trapped in false breaks, taking painful losses, and eventually hesitating to act when the real move finally came.

The Put Ratio Backspread Strategy

Read also: US-Iran Tensions Spark Uptick in Oil Prices Amid Global Market Decline

The Put Ratio Backspread is a strategy that can help traders navigate consolidation and profit from the eventual move. The structure involves selling one lot of a put and buying two lots of a lower put. For example, selling a 24,900 Put at Rs 277 and buying a 24,800 Put at Rs 240 results in a net premium paid of Rs 203.

Example 1

• Sell 1 lot of 24,900 Put at Rs 277
• Buy 2 lots of 24,800 Put at Rs 240
• Net premium paid: Rs 203

Example 2

• Sell 1 lot of 25,300 Put at Rs 503
• Buy 2 lots of 24,900 Put at Rs 277
• Net premium paid: Rs 51

Timing and Profit

To deploy this strategy effectively, traders should follow two key rules: deploy the strategy in the first half of the expiry cycle, never close to expiry, and exit and reassess if the market hasn't moved sharply within three days. The Put Ratio Backspread strategy profits from both the directional fall and the surge in volatility that typically accompanies a sharp decline, making it an attractive option for traders looking to navigate consolidation.