Long Call Ladder Explained

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Long Call

The Strategy

A long call gives you the right to buy the underlying stock at strike price A.

Calls may be used as an alternative to buying stock outright. You can profit if the stock rises, without taking on all of the downside risk that would result from owning the stock. It is also possible to gain leverage over a greater number of shares than you could afford to buy outright because calls are always less expensive than the stock itself.

But be careful, especially with short-term out-of-the-money calls. If you buy too many option contracts, you are actually increasing your risk. Options may expire worthless and you can lose your entire investment, whereas if you own the stock it will usually still be worth something. (Except for certain banking stocks that shall remain nameless.)

Options Guy’s Tips

Don’t go overboard with the leverage you can get when buying calls. A general rule of thumb is this: If you’re used to buying 100 shares of stock per trade, buy one option contract (1 contract = 100 shares). If you’re comfortable buying 200 shares, buy two option contracts, and so on.

If you do purchase a call, you may wish to consider buying the contract in-the-money, since it’s likely to have a larger delta (that is, changes in the option’s value will correspond more closely with any change in the stock price). You can learn more about delta in Meet the Greeks. Try looking for a delta of .80 or greater if possible. In-the-money options are more expensive because they have intrinsic value, but you get what you pay for.

The Setup

  • Buy a call, strike price A
  • Generally, the stock price will be at or above strike A

Who Should Run It

Veterans and higher

NOTE: Many rookies begin trading options by purchasing out-of-the-money short-term calls. That’s because they tend to be cheap, and you can buy a lot of them. However, they’re probably not the best way to get your feet wet. The Rookie’s Corner suggests other plays more suited to beginning options traders.

When to Run It

You’re bullish as a matador.

Break-even at Expiration

Strike A plus the cost of the call.

The Sweet Spot

The stock goes through the roof.

Maximum Potential Profit

There’s a theoretically unlimited profit potential, if the stock goes to infinity. (Please note: We’ve never seen a stock go to infinity. Sorry.)

Maximum Potential Loss

Risk is limited to the premium paid for the call option.

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Ally Invest Margin Requirement

After the trade is paid for, no additional margin is required.

As Time Goes By

For this strategy, time decay is the enemy. It will negatively affect the value of the option you bought.

Implied Volatility

After the strategy is established, you want implied volatility to increase. It will increase the value of the option you bought, and also reflects an increased possibility of a price swing without regard for direction (but you’ll hope the direction is up).

Check your strategy with Ally Invest tools

  • Use the Profit + Loss Calculator to establish break-even points, evaluate how your strategy might change as expiration approaches, and analyze the Option Greeks.
  • Remember: if out-of-the-money options are cheap, they’re usually cheap for a reason. Use the Probability Calculator to help you form an opinion on your option’s chances of expiring in-the-money.
  • Use the Technical Analysis Tool to look for bullish indicators.

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A FEW THINGS YOU SHOULD KNOW

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Ladder Option

What Is a Ladder Option?

A ladder option is an exotic option that locks in partial profits once the underlying asset reaches predetermined price levels or “rungs.” This guarantees at least some profit, even if the underlying asset retraces beyond these levels before the option expires. Ladder options come in put and call varieties.

Do not confuse ladder options, which are specific types of options contracts, with long call ladders, long put ladders, and their short counterparts, which are options strategies that involve buying and selling multiple options contracts simultaneously.

How a Ladder Option Works

Ladder options are similar to traditional option contracts that give the holder the right, but not the obligation to buy or sell the underlying asset at a predetermined price at or by a predetermined date. However, a ladder option adds a feature that allows the holder to lock in partial profits at predetermined intervals.

These intervals are fittingly called “rungs” and the more rungs the price of the underlying asset crosses, the more profit locks in. The holder keeps profits based on the highest rung achieved (for calls) or the lowest rung achieved (for puts) regardless if the price of the underlying crosses back below (for calls) or above (for puts) those rungs before expiration.

Because the holder earns non-returnable partial profits as the trade develops, total risk is much lower than for traditional vanilla options. The trade-off, of course, is that ladder options are more expensive than similar vanilla options.

Example of a Ladder Option

Consider a ladder call option where the underlying asset price is 50 and the strike price is 55. Rungs are set at 60, 65, and 70. If the underlying price reaches 62, the profit locks in at 5 (rung minus strike or 60 – 55). If the underlying reaches 71, then the locked in profit increases to 15 (new rung minus strike or 70 – 55), even if the underlying falls below these levels before the expiration date.

As with vanilla options, there is time value associated with ladder options. Therefore, the traded price for call options is usually above the locked in profit amount, and declining as the expiration date approaches.

If the price of the underlying falls below any of the triggered rungs, again for calls, it almost does not matter to the price of the option because the partial profit is guaranteed. Although, this is an oversimplification because the lower the underlying moves below the highest triggered rung, the less likely it will be to rally back to exceed that rung and reach the next rung.

Bear Call Ladder Options Trading Strategy In Python

By Viraj Bhagat We have previously come across the following strategies:

  • Iron Condor Trading Strategy is a combination of the Bull Put Spread and Bear Call Spread Options trading strategy
  • Butterfly Spread Trading Strategy is a combination of Bull Spread and Bear Spread, a Neutral Trading Strategy

These Options Trading Strategies are a combination of both a Bull Spread and a Bear Spread. I would be taking you through the Bear Call Ladder that is also an extension to the Bear Call Spread and explain the strategy using a Live Trading Market example by coding the strategy in Python.

What Are Ladders In Trading?

Ladders are an options contract (call or put) that allow earning profits till the market price of the asset reaches one or more strike prices before the option expires. It resets during specific trade levels by capping the profit between the old strike and the new strike price in either or both directions, thus allowing flexibility in the payoff. Like the rungs of a ladder, the trigger strikes reduce risk and once the market price of the asset reaches the trigger, it locks in the profit, thus increasing the profitability.

What Is A Bear Call Ladder?

The Bear Call Ladder is also known as the ‘Short Call Ladder’ and is an extension to the Bear Call Spread. Although this is not a Bearish Strategy, it is implemented when one is bullish. It is usually set up for a ‘net credit’ and the cost of purchasing call options is financed by selling an ‘in the money’ call option. For this Options Trading Strategy, one must ensure the Call options belong to the same expiry, the same underlying asset and the ratio are maintained. It mainly protects the downside of a Call sold by insuring it i.e. by buying a Call of a higher strike price. It is essential though that you execute the strategy only when you are convinced that the market would be moving significantly higher.

Choosing The Bear Call Ladder Trading Strategy

Setup Of A Bear Call Ladder Trading Strategy

The Bear Call Ladder is a 3 legged option strategy, usually set up for a “net credit”, for the same underlying instrument with a higher exercise date and price and for the same expiry date. The Bear Call Ladder will look something like this:

Options Selection

  • Select Options with good liquidity
  • Open interest should be at least 100, preferably 500
  • Lower Strike – ITM
  • Middle Strike – One or two strikes above the lower strike, i.e., further OTM
  • Higher Strike – Above the middle strike, i.e., even further OTM

Execution

  • Selling 1 ITM call option
  • Buying 1 ATM call option
  • Buying 1 OTM call option

Executed in a 1:1:1 ratio combination, i.e. for every 1 ITM Call option sold, 1 ATM and 1 OTM Call option has to be bought. (ie by selling 1 ITM, buying 1 ATM, and 1 OTM) Other possible combinations are 2:2:2 or 3:3:3 (so on and so forth).

Preference Over Call Ratio Spread

  • An improvisation over the Call Ratio Spread
  • The Call Ratio Spread is created using Call Options, buying 1 ITM Call and selling 2 ATM Call options. More options are sold than bought, making the excess option coverless which is a risk to the trader.
  • Here, the cost of execution is better than the call ratio spread (due to this the range above which the market has to move also becomes large)
  • Cash flow is invariably better since the Call bought is of a higher strike price than the Call sold

Risk

Trader or investor buys more calls than they are selling, therefore, Limited Max. Risk

Breakeven

  • Lower Breakeven = Lower Strike + Net Credit
  • Upper Breakeven = Long Strike – Short Strike – Net Premium

Net Credit = Premium Received from ITM CE – Premium paid to ATM & OTM CE Payoff = When the market goes down = Net Credit

Expiration

Term: Only the Nifty options are of 6 months and are liquid, unlike others. Around 6 months would be safer. Use the same expiration date for all legs.

Alternatives Before Expiry

  • Common Practise: Close before expiry to capture profit OR Since there are 2 Long Calls, stem the loss
  • Best: Close from Medium term to Expiry
  • Alternatives After Expiry: Closeout. Sell the purchased calls and buy back the calls sold

The Advantage Of Bear Call Ladder

The biggest advantage here is the ability to profit in 4 out of 5 possible moves in the underlying asset and an Unlimited profit to upside movement

The Disadvantage Of A Bear Call Ladder

Since it is a net credit spread, the margin is needed

Example Of Bear Call Ladder Options Trading Strategy

If ABC is currently trading at 50. The markets are expected to rise. So here’s what the trader does:

  • Sell 1 ITM 55 strike call for INR 5
  • Buying 1 ATM 60 strike call for INR 2.5
  • Buying 1 OTM 65 strike call for INR 1

The investor can get an inflow of the premium of 1.5 and benefit if the ABC stays below 500.

  • Net Credit = Premium Sold – Premium Bought = 5 – 2.5 – 1 = 1.5
  • Maximum Risk = Middle Strike – Lower Strike + Net Debit (or – Net Credit) = 60 – 55 – 1.5 = 3.5
  • Maximum Reward = Unlimited
  • Breakeven (Downside) = Lower Strike + Net Debit (or + Net Credit) = 55 + 1.5 = 56.5
  • Breakeven (Upside) = Higher Strike + Maximum Risk = 65 + 3.5 = 68.5

Live Example

To explain the Bear Call Ladder Trading Strategy, we would be using the following Live Market Example of the State Bank of India (Ticker: SBI) currently using the Options Chain obtained from nseindia.com.

Python Code For Bear Call Ladder Strategy

Import Library

Calculate Payoff

Long Call 1 Payoff

Long Call 2 Payoff

Short Call Payoff

Bear Call Ladder Payoff

Bear Call Ladder

Conclusion

The Bear Call Ladder or Short Call Ladder is best to use when you are confident that an underlying security would be moving significantly. It is a limited risk and an unlimited reward strategy if the movement comes on the higher side.

Next Step

Are you keen on learning more about algorithmic trading? Connect with us and get to know different worldviews on financial strategies. QuantInsti® aids people in acquiring skill sets which can be applied across various trading instruments and platforms. The Executive Programme in Algorithmic Trading (EPAT™) course covers training modules like Statistics & Econometrics, Financial Computing & Technology, and Algorithmic & Quantitative Trading. EPAT™ equips you with the required skill sets to be a successful trader. Disclaimer: All investments and trading in the stock market involve risk. Any decisions to place trades in the financial markets, including trading in stock or options or other financial instruments is a personal decision that should only be made after thorough research, including a personal risk and financial assessment and the engagement of professional assistance to the extent you believe necessary. The trading strategies or related information mentioned in this article is for informational purposes only.

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