Short Call Ladder Explained

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
    Get a Sign-Up Bonus Now!

  • Binomo
    Binomo

    2nd in our ranking!

Short Call Ladder

The short call ladder, or bear call ladder, is an unlimited profit, limited risk strategy in options trading that is employed when the options trader thinks that the underlying security will experience significant volatility in the near term.

Short Call Ladder Construction
Sell 1 ITM Call
Buy 1 ATM Call
Buy 1 OTM Call

To setup the short call ladder, the options trader sells an in-the-money call, purchases an at-the-money call and purchases another higher strike out-of-the-money call of the same underlying security and expiration date.

Limited Downside, Unlimited Upside Profit Potential

Maximum gain for the short call ladder strategy is limited if 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.

The formula for calculating profit is given below:

  • Maximum Profit = Unlimited
  • Profit Achieved When Price of Underlying > Total Strike Prices of Long Calls – Strike Price of Short Call + Net Premium Received
  • Profit = Price of Underlying – Upper Breakeven

Limited Risk

Losses are limited when employing the short call ladder strategy and maximum loss occurs when the stock price is between the strike prices of the two long calls on expiration date. At this price, the higher striking long call expires worthless while the lower striking long call is worth much less than the short call, thus resulting in a loss.

The formula for calculating maximum loss is given below:

  • Max Loss = Strike Price of Lower Strike Long Call – Strike Price of Short Call – Net Premium Received + Commissions Paid
  • Max Loss Occurs When Price of Underlying is in between the Strike Prices of the 2 Long Calls

Breakeven Point(s)

There are 2 break-even points for the short call ladder position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Total Strike Prices of Long Calls – Strike Price of Short Call + Net Premium Received
  • Lower Breakeven Point = Strike Price of Short Call – Net Premium Received

Example

Suppose XYZ stock is trading at $35 in June. An options trader executes a short call ladder strategy by selling a JUL 30 call for $600, buying a JUL 35 call for $200 and a JUL 40 call for $100. The net credit received for entering this trade is $300.

In the event that XYZ stock rallies and is trading at $50 on expiration in July, all the call options will expire in the money. The long JUL 35 call will expire with $1500 in intrinsic value while the long JUL 40 call will expire with $1000 in intrinsic value.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
    Get a Sign-Up Bonus Now!

  • Binomo
    Binomo

    2nd in our ranking!

Buying back the short JUL 30 call will only cost the options trader $2000. So selling the long calls and buying back the short call will leave the trader with a $500 gain. Together with the initial credit of $300, his total profit comes to $800. This profit can be even higher if the stock had rallied beyond $50.

However, if the stock price had dropped to $30 instead, all the calls will expire worthless and his profit will only be the initial credit of $300 received.

On the other hand, let’s say XYZ stock remains at $35 on expiration date. At this price, only the short JUL 30 call will expire in the money with an intrinsic value of $500. Taking into account the initial credit of $300, buying back this call to close the position will leave the trader with a $200 loss – this is also his maximum possible loss.

Note: While we have covered the use of this strategy with reference to stock options, the short call ladder is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the short call ladder in that they are also high volatility strategies that have unlimited profit potential and limited risk.

Long Call Ladder

The long call ladder, or bull call ladder, is a limited profit, unlimited risk strategy in options trading that is employed when the options trader thinks that the underlying security will experience little volatility in the near term. To setup the long call ladder, the options trader purchases an in-the-money call, sells an at-the-money call and sells another higher strike out-of-the-money call of the same underlying security and expiration date.

Long Call Ladder Construction
Buy 1 ITM Call
Sell 1 ATM Call
Sell 1 OTM Call

The long call ladder can also be thought of an extension to the bull call spread by selling another higher striking call. The purpose of shorting another call is to further finance the cost of establishing the spread position at the expense of being exposed to unlimited risk in the event that the underlying stock price rally explosively.

Limited Profit Potential

Maximum gain for the long call ladder strategy is limited and occurs when the underlying stock price on expiration date is trading between the strike prices of the call options sold. At this price, while both the long call and the lower strike short call expire in the money, the long call is worth more than the short call.

The formula for calculating maximum profit is given below:

  • Max Profit = Strike Price of Lower Strike Short Call – Strike Price of Long Call – Net Premium Paid – Commissions Paid
  • Max Profit Achieved When Price of Underlying is in between the Strike Prices of the 2 Short Calls

Limited Downside Risk, Unlimited Risk to the Upside

Losses is limited to the initial debit taken if the stock price drops below the lower breakeven point but large unlimited losses can be suffered should the stock price makes a dramatic move to the upside beyond the upper breakeven point.

The formula for calculating loss is given below:

  • Maximum Loss = Unlimited
  • Loss Occurs When Price of Underlying > Total Strike Prices of Short Calls – Strike Price of Long Call – Net Premium Paid
  • Loss = Price of Underlying – Upper Breakeven Price + Commissions Paid

Breakeven Point(s)

There are 2 break-even points for the long call ladder position. The breakeven points can be calculated using the following formulae.

  • Upper Breakeven Point = Total Strike Prices of Short Calls – Strike Price of Long Call – Net Premium Paid
  • Lower Breakeven Point = Strike Price of Long Call + Net Premium Paid

Example

Suppose XYZ stock is trading at $35 in June. An options trader executes a long call ladder strategy by buying a JUL 30 call for $600, selling a JUL 35 call for $200 and a JUL 40 call for $100. The net debit required for entering this trade is $300.

Let’s say XYZ stock remains at $35 on expiration date. At this price, only the long JUL 30 call will expire in the money with an intrinsic value of $500. Taking into account the initial debit of $300, selling this call to close the position will give the trader a $200 profit – which is also his maximum possible profit.

In the event that XYZ stock rallies and is trading at $50 on expiration in July, all the call options will expire in the money. The short JUL 35 call will expire with $1500 in intrinsic value while the short JUL 40 call will expire with $1000 in intrinsic value. Selling the long JUL 30 call will only give the options trader $2000 so he still have to top up another $500 to close the position. Together with the initial debit of $300, his total loss comes to $800. The loss could have been worse if the stock had rallied beyond $50.

However, if the stock price had dropped to $30 instead, all the calls will expire worthless and his loss will be the initial $300 debit taken to enter the trade.

Note: While we have covered the use of this strategy with reference to stock options, the long call ladder is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).

Similar Strategies

The following strategies are similar to the long call ladder in that they are also low volatility strategies that have limited profit potential and unlimited risk.

Short Call Ladder Spread

Short Call Ladder Spread – Definition

An options strategy consisting of buying an additional higher strike price call option on a bear call spread in order to transform the position from a bearish strategy to a volatile strategy.

Short Call Ladder Spread – Introduction

The Short Call Ladder Spread, also known as the Bear Call Ladder Spread, is an improvement to the Bear Call Spread, transforming it from an options strategy that profits only when the underlying stock goes downwards into a volatile strategy that profits when the underlying stock goes upwards or downwards with unlimited profit potential to upside.

This tutorial shall explain what the Short Call Ladder Spread is, its calculations, pros and cons as well as how to profit from it.

Short Call Ladder Spread – Classification

Type of Strategy : Volatile | Type of Spread : Vertical Spread | Debit or Credit : Credit

The Short Call Ladder Spread is part of the “Ladder Spreads” family. Ladder Spreads add an additional further out of the money option on top of two legged spreads, stepping the position up by another strike price. The use of progressively higher or lower strike prices in a single spread gave “Ladder Spreads” its name.

When To Use Short Call Ladder Spread?

The Short Call Ladder Spread could be used when the price of the underlying stock is expected to remain stagnant, drop moderately or rally significantly.

How To Use Short Call Ladder Spread?

Short Call Ladder is made up of writing an At The Money Call Option, buying an equivalent amount of a higher strike price Out Of The Money Call Option and then buying yet another equivalent amount of an even higher strike price out of the money call option.

Sell ATM Call + Buy OTM Call + Buy Higher Strike OTM Call

Short Call Ladder Spread Example

Assuming QQQ trading at $44.

Sell To Open 1 contract of QQQ Jan44Call, Buy To Open 1 contract of QQQ Jan46Call and Buy To Open 1 contract of QQQ Jan47Call.

Choosing Strike Prices For Short Call Ladder Spread

Short Leg
The short leg of a Short Call Ladder Spread is usually the At The Money option or a strike price that is nearest the money. This is because the primary profit of a Short Call Ladder Spread, which is the net credit of the position made when the underlying stock remains stagnant or moves downwards, requires as high an extrinsic value as possible and At The Money options contain the highest extrinsic value within the same expiration month.

Middle Strike Price
The closer the middle strike price is to the strike price of the short leg, the more expensive it is and the lower the resultant net credit becomes. This results in a lower profit when the underlying stock remains stagnant or moves downwards as well as a lower maximum loss. The further the middle strike price is to the short leg, the higher the net credit becomes, resulting in a higher profit when the underlying stock remains stagnant or moves downwards and also a higher maximum loss. It also affects the upside breakeven point as it becomes further away as well. This means that the underlying stock would have to rally more in order to start profiting to upside.

As such, in a Short Call Ladder Spread, options traders usually buy the middle strike price two strike prices higher than the short leg for stocks with strike prices at $1 interval or one strike price higher for stocks with strike prices at $5 interval, in order to obtain a more balanced risk profile.

Higher Strike Price
The difference in strike price between the middle strike and the higher strike determines the price range over which maximum loss will occur for a Short Call Ladder Spread. In our QQQ example above, maximum loss will occur when the QQQ closes between $46 (middle strike) and $47 (higher strike) by expiration. Increasing the strike difference between the higher strike and the middle strike results in only a very small increase in net credit but pushes up the higher breakeven point even further and increases the price range over which maximum loss occurs without significant decrease in maximum loss amount. As such, the higher strike price is usually bought just one strike higher than the middle strike price in a Short Call Ladder Spread.

Trading Level Required For Short Call Ladder Spread

A Level 4 options trading account that allows the execution of credit spreads is needed for the Short Call Ladder Spread. Read more about Options Account Trading Levels.

Profit Potential of Short Call Ladder Spread

Short Call Ladder Spread profits in all 3 directions; When the underlying stock goes downwards (strongly or moderately), remains stagnant or goes upwards strongly. Indeed, the Short Call Ladder Spread has made profitable 4 out of 5 possible outcomes which makes its probability of profit extremely high.

For the stagnant and downwards movement, the Short Call Ladder Spread profits primarily through the net credit gained from writing the higher extrinsic value ATM call options and buying cheaper OTM call options. As long as the price of the underlying stock remains below the strike price of the ATM call options, the net credit is made as profit.

When the price of the underlying stock rally strongly, it will come to a point beyond the strike price of the higher strike call options when the two long call legs will profit more than the single short call leg, resulting in unlimited profit to upside.

Profit Calculation of Short Call Ladder Spread

Maximum Upside Profit = Unlimited
Maximum Downside Profit = Net Credit

Maximum Loss = Lower Long Call Strike – Short Call Strike – Net Credit

Short Call Ladder Spread Calculations

Following up on the above example, assuming QQQQ at $46.50 at expiration.

Wrote the JAN 44 Call for $1.50
Bought the JAN 46 Call for $0.50
Bought the JAN 47 Call for $0.15

Net Credit = $1.50 – $0.50 – $0.15 = $0.85

Maximum Loss = 46 – 44 – 0.85 = $1.15

Max. Upside Profit = Unlimited

Max. Downside Profit = $0.85

Risk / Reward of Short Call Ladder Spread

Maximum Upside Profit : Unlimited

Maximum Downside Profit: Limited to net credit received

Maximum Loss: Limited

Break Even Point of Short Call Ladder Spread

There are 2 break even points to a Short Call Ladder Spread. Loss will occur if the underlying stock closes within the upper and lower breakeven point by expiration.

Upper BEP: Higher Long Strike + Strike difference between short Call and lower long call – Net Credit

Lower BEP: Short Call Strike + Net Credit

Short Call Ladder Spread Breakeven Points Calculation

Upper BEP = $47 + ($46 – $44) – $0.85 = $48.15

Lower BEP = $44 – $0.85 = $43.15

Short Call Ladder Spread Greeks

Delta : Negative
Delta of near month Short Call Ladder Spread is negative at the start. As such, its value will increase as the price of the underlying stock decreases. Delta becomes higher and turns positive with longer expiration month.

Gamma : Positive
Gamma of Short Call Ladder Spread is positive for a start and will will increase overall position delta into the positive allowing the position to profit to upside.

Theta : Negative
Theta of Short Call Ladder Spread is negative for a start and will therefore lose value due to time decay in the short term prior to expiration as the long call legs lose value faster than the short call leg. However, as the short call leg contains more extrinsic value than the long call legs combined, theta will turn positive as expiration approaches, resulting in a profit even if the price of the underlying stock remains stagnant.

Vega : Increases with Length of Expiration
Vega of Short Call Ladder Spread can start slightly negative with near term options and increase to positive as longer expiration options are used. When this is the case, the position would profit on an increase in implied volatility, usually when the underlying stock declines.

Advantages Of Short Call Ladder Spread

:: Able to profit in 4 out of 5 possible moves in the underlying stock

:: Unlimited profit to upside

Disadvantages Of Short Call Ladder Spread

:: Small margin needed as it is a credit spread.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Best Binary Options Broker 2020!
    Good Choice for Beginners!
    Free Trading Education, Free Demo Account!
    Get a Sign-Up Bonus Now!

  • Binomo
    Binomo

    2nd in our ranking!

Like this post? Please share to your friends:
How To Start Binary Options Trading 2020
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: