Bear
Put Ladder
Description
The
Bull Put Ladder is an extension to the Bull Put Spread. By buying another put
at a lower strike, the position assumes uncapped reward potential if the stock plummets.
The problem is that now its not totally clear if we have a bullish or bearish
strategy, but because we are net long puts and we have uncapped profit
potential if the stock falls, do we have to call this a bearish strategy? The
answer lies in the reason for the trade and the position of the stock relative
to the strikes.
Because
we are net long options (and particularly OTM options), we are better off
trading this as a longer-term strategy in order to counter the effects of time
decay.
So,
in summary, if the stock falls below the lower (buy) strike, we make
potentially uncapped profit until the stock reaches zero; if the stock rises to
anywhere between the middle and upper (short) strikes, we make our maximum
loss. The extra leg also ensures that we may have two break even points.
Market
Opinion
Conservatively
bearish.
P/L
When
To Use
Use
this strategy when your outlook is conservatively bearish and you want income.
Example
XXXX
is trading at $26.10 on May 10, 2011.
Sell
June 2011 $22.50 strike call for $0.30.
Sell
June 2011 25 strike call for $1.00.
Buy
June 2011 $27.50 strike call for $2.40.
Benefit
Your
cost for this strategy would be lower than doing a bear put spread. And the
farther away from expiration, the more protection on the downside.
Risk
vs. Reward
The
risk is unlimited on the downside as you are selling more puts than buying. The
reward is the difference between the middle and higher strike prices minus your
net debit or net credit.
Net
Upside
There
is limited profit potential
Net
Downside
Lower
strike minus (higher strike minus middle strike) plus net debit.
Break
Even Point
Lower
break even point: total strike prices of short puts minus strike price of long
put plus premium paid.
Upper
break even point: Strike price of long put minus premium paid.
Effect
Of Volatility
Minimal
to low effect.
Effect
Of Time Decay
Positive
when your position is profitable.
Alternatives
Before Expiration
You
can sell the long put if your stock rises above stop loss, or close out the
whole position.
Alternatives
After Expiration
Close
position by buying back puts sold and selling puts bought.