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:
- 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
- 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
|Max.||Uncapped Potential (all long and short calls expire worthless, the Initial Credit Recd. limits the Max Profit)||Limited and is Max. at ATM and OTM Strike|
|Max. Upside||Unlimited (underlying price rises suddenly, due to the extra-long call)||Middle Strike – Lower Strike – Net Premium Gain|
|Max. Downside||Limited to net credit received||ITM1 – ITM2 options – Net Credit
Middle Strike Price – Lower Strike Price – Net Credit
Trader or investor buys more calls than they are selling, therefore, Limited Max. Risk
- 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
Tips: - Understand the direction of the trend - Identify a clear area of support - Identify the resistance
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
|Type||Strike Price (INR)||Premium (INR)|
|Sell ITM Call||55||5.00|
|Buy ATM Call||60||2.50|
|Buy OTM Call||65||1.00|
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.
|Spot Price||OTM Long Call||ATM Long Call||ITM Short Call|
Python Code For Bear Call Ladder Strategy
import numpy as np import matplotlib.pyplot as plt import seaborn seaborn.set(style="darkgrid")
def call_payoff (sT, strike_price, premium): return np.where(sT> strike_price, sT-strike_price, 0)-premium # SBI spot Price s0 = 250 # Long Call OTM_long_call = 260 premium_OTM_long_call = 2.15 ATM_long_call = 250 premium_ATM_long_call = 5.65 # Short Call ITM_short_call = 240 premium_ITM_short_call = 12.50 # Range of call option at epiration sT = np.arange(200,300,1)
Long Call 1 Payoff
OTM_long_call_payoff = call_payoff(sT, OTM_long_call,premium_OTM_long_call) fig, ax = plt.subplots() ax.spines['bottom'].set_position('zero') ax.plot(sT,OTM_long_call_payoff, color='g') ax.set_title('LONG 30 Strike Call') plt.xlabel('Stock Price') plt.ylabel('Profit & Loss') plt.show()
Long Call 2 Payoff
ATM_long_call_payoff = call_payoff(sT, ATM_long_call, premium_ATM_long_call) fig, ax = plt.subplots() ax.spines['bottom'].set_position('zero') ax.plot(sT,ATM_long_call_payoff, color='g') ax.set_title('LONG 35 Strike Call') plt.xlabel('Stock Price (sT)') plt.ylabel('Profit & Loss') plt.show()
Short Call Payoff
ITM_Short_call_payoff = call_payoff(sT, ITM_short_call, premium_ITM_short_call)*-1.0 fig, ax = plt.subplots() ax.spines['bottom'].set_position('zero') ax.plot(sT, ITM_Short_call_payoff, color='r') ax.set_title('Short 32.5 Strike Call') plt.xlabel('Stock Price') plt.ylabel('Profit & Loss') plt.show()
Bear Call Ladder Payoff
Bear_call_ladder = OTM_long_call_payoff + ATM_long_call_payoff + ITM_Short_call_payoff fig, ax = plt.subplots(figsize=(8,5)) ax.spines['bottom'].set_position('zero') ax.plot(sT,Bear_call_ladder,color='b', label= 'Bear Call Ladder') ax.plot(sT, ATM_long_call_payoff,'--', color='g',label='ATM Long Call') ax.plot(sT, OTM_long_call_payoff,'--', color='g', label='OTM Long Call') ax.plot(sT, ITM_Short_call_payoff, '--', color='r', label='ITM Short call') plt.legend() plt.xlabel('Stock Price') plt.ylabel('Profit & Loss') plt.show()
Bear Call Ladder
Bear_call_ladder = OTM_long_call_payoff + ATM_long_call_payoff + ITM_Short_call_payoff fig, ax = plt.subplots(figsize=(8,5)) ax.spines['bottom'].set_position('zero') ax.plot(sT,Bear_call_ladder,color='b', label= 'Bear Call Ladder') plt.legend() plt.xlabel('Stock Price') plt.ylabel('Profit & Loss') plt.show()
Profit = max(Bear_call_ladder) Loss = min(Bear_call_ladder) print Profit print Loss
Max. Profit: 33.7 Max. Loss: -5.30
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.
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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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- Bear Call Ladder Options Strategy – Python Code