How to Design a 1:2 Risk Reward Ratio Trade using Bear Put Spread?

How to Design a 1:2 Risk Reward Ratio Trade using Bear Put Spread?

While trading the debit strategies measuring the risk-reward ratio matters a lot for the options trader. Though you might have a bearish opinion about the market. However, the overall objective of the trader is to maximize the gain and minimize the losses.

HDFCBANK

Generally, debit strategies have a better risk-reward ratio compared to credit strategies. Let’s look into the bear put spread HDFC Bank example where the view is HDFC Bank hitting 970 in the short term before this expiry. It is basically the view here is bearish from a positional point of view.

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Any time decay could eat up the premium and hence to trade the view we need to mitigate the risk with the hedged position. Since the expectation is towards making a test towards sub-1000 levels.

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HDFCBANK LTP : 1103 (Underlying Spot)

In order to trade this strategy one can initiate ITM Long Put Option of 30th July expiry i.e at 1120PE at 38.69 CE

And to reduce the risk of premium erosion, adding a hedge 1000PE (Shorting 1000PE July Expiry at Rs 8.65) one can reduce the net debit cost of the put option and also the max expected returns too improved as we are shorting 1000PE which is the also the expected target level.

Net Cost of Debit Spread = 38.69 – 8.7 = Rs 30
Max Total Loss = 30 x 550 = Rs 16500 per lot

Total Gain Anticipated at 1000: 15,000 to 38500
Max Possible Gain on Expiry: 38500

Strategy Break even Levels : 1070

Max Possible Risk reward Ratio : 1:2.33

Total Margin Required to execute on set of spread Rs 21,222 (approx)

Related Readings and Observations

Source: Marketcalls

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