Bear Call Ladder

                                               

Description:

 

A Bear Call Ladder entails selling a call that is in-the-money, buying a call that is at-the-money, and buying a call that is out-of-the-money for the same underlying instrument with a higher exercise date and price.

 

The Bear Call Ladder also known as the Short Call Ladder is an extension of the Bear Call Spread. By buying another call at a higher strike, the position assumes uncapped reward potential if the stock soars. Maximum gain for the short call ladder strategy is limited when the underlying stock price goes down. In this scenario, maximum profit is limited to the initial credit received since all the long and short calls will expire worthless. However, if the underlying stock price rallies explosively, potential profit is unlimited due to the extra long call.

 

Market Opinion

 

Bullish.

 

P/L

 

 

When to Use

 

A bear call ladder is used when the trader or investor believes that the stock will rise and also experience volatility, and is aiming to make a capital gain.

 

Example

 

XYZ is trading at $48.00 on May 17, 2004.

 

Sell the August 2004 50 strike call for $4.20.

 

Buy the August 2004 55 strike call for $2.40.

 

Buy the August 2004 60 strike call for $0.80.

 

Net Credit = Premium sold - premiums bought

$4.20 - $2.40 - $0.80 = $1.00

 

Benefit

 

Unlimited upside profit potential with limited downside.

 

Risk vs. Reward

 

The risk is that the trader or investor is speculating that a stock will make a big move to the upside. There is limited maximum risk because the trader or investor buys more calls than they are selling.

 

Net Upside

 

Unlimited upside.

 

Net Downside

 

Difference between middle strike price and lower strike price minus net credit.

 

Break Even Point

 

Breakeven (Downside) = Lower strike + net debit (or + net credit)

$50.00 + $1.00 = $51.00

 

Breakeven (Upside) = Higher strike + maximum risk

$60.00 + $4.00 = $64.00

 

Volatility

 

Volatility is the friend of this strategy. The more volatility, the more positive the effect.

 

Effect of Time Decay

 

Time decay is generally harmful when the position is losing money and helpful when the position is profitable.

 

Alternatives Before Expiration

 

 

Most traders and investors try to aim for closing out before expiration to capture profit, or stem loss because there are two long calls. Closing out from medium term to expiration would be the best strategy.

 

 

Alternatives After Expiration

 

Close out. Buy the back the calls sold and sell the calls bought.

 

Additional:

 

Stock Selection

 

Choose from stocks with adequate liquidity, preferably over 500,000 Average Daily Volume (ADV).

 

Try to ensure you understand the direction of the trend and identify a clear area of both support and resistance

 

Options Selection

 

Choose options with good liquidity; open interest should be at least 100, preferably 500.

Lower Strike - Slightly OTM, just above resistance for the stock.

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.

Expiration- medium term to expiration (say around six months) would be safer. Use same expiration date for all legs.