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.