A Short Breakdown of the Bear Call Ladder Strategy
Ladder option strategies are often used to take advantage of trends in the underlying stocks. For example, if you’re bullish on Apple Inc., you can go long on the stock, but this strategy can also be used to profit from a bearish outlook as well.
One popular ladder strategy for bearish investors, called the Bear Call Ladder strategy, involves using call options to profit from an anticipated drop in the price of the underlying stock or ETF (exchange-traded fund).
Here’s how it works.
What is a Bear Call Ladder?
Short-selling a share of stock has many potential benefits that you can take advantage of.
One strategy - the bear call ladder - is used when you believe stocks will fall. A bear call ladder offers undefined profit if prices rise beyond a certain point and profitable returns if they fall below this point but offer losses when they only rise slightly enough to trigger losses.
This trading is also known as the short call ladder and this is a net credit strategy.
It relies on three simultaneous deals involving the options listed below:
Bear Call Ladder
- Sell one ITM call
- Buy one ATM call
- Purchase one OTM call option - all with the same expiration date and underlying security.
A bear call ladder is one option strategy that offers unlimited returns if the stock price rises beyond a certain point.
In other words, it offers unlimited potential for gain on limited risk.
The idea behind a bear call ladder involves the use of various expiration dates and strike prices within options to achieve the desired effect.
The ladder creator makes money by collecting the time value premium within each option contract and rolling out at-the-money contracts into higher ones when they expire while also capitalizing on any price movement in the underlying stock that takes place before then.
It's a relatively straightforward strategy that can be structured in a variety of ways depending on which stocks you want to include or what your goals are.
Bear Call Ladder Strategy Example:
For example, you may buy a $50 call with six months left until expiry as well as another $45 call with three months left until expiry.
If this trade works out, you’ll have made money from both calls since their premiums will be worth more than their intrinsic values.
You’ll make even more money if there’s significant price appreciation over those three months.
How Does the Bear Call Ladder Work?
A bear call spread trade is when you buy a call option at a lower price than the strike price and sell it at a higher price to make money off of the difference in price.
A trader might do this because they think the stock will go down.
When you sell a call option, you want to earn profit as soon as possible; waiting for too long means you might miss out on profitable trading opportunities. A bear call ladder ensures your options expire quickly while still being covered by other strike prices in case they lose their value or if something goes wrong.
Bear call ladders also have a useful feature called time decay which is known as theta, which is another way to earn money faster than selling one option at a time. If your option is sold for less than its strike price, it has a lower value than when it was first sold; its value will continue to go down if it's not bought at that price, which means traders can buy options and earn more money after holding them for only one day.
The concept behind it is simple: You sell an out-of-the-money call option with a short expiration date, then you use some of that money to buy two or three higher strike price calls at a later date.
To understand why these options are sold at a discount, we need to look at what happens when you buy an option.
First, there’s no guarantee that your investment will make money because stock prices could drop instead of rise (which would mean you lose money).
Options are risky investments because they give investors limited control over stocks—they don’t own shares outright but instead, have rights to purchase shares within a specific timeframe.
Benefits and Risks Associated with Using Bear Call Ladder Strategy
The main benefit of using a bear call ladder strategy is that it puts you in control. You know how much you will pay for an option if and when it gets assigned, and that can be pretty empowering. It also protects your downside, so in terms of risk management, it’s a very appealing strategy.
There are some disadvantages to consider as well.
The first is that you must have enough cash on hand to cover each trade and each premium payment as they come due. That means that if you want to employ a bear call ladder strategy with more than one strike price, you need more money than would be required with other strategies.
Also, because there is no margin involved (and because options expire), there is no opportunity to roll positions forward or adjust them before expiration arrives.
This means that even though you know exactly what your cost basis will be at any given time, there isn’t anything you can do about it until expiration arrives—which could potentially cause problems if things don’t go according to plan.
If your outlook changes between now and then (or if market conditions change), all you can do is wait for expiration day—at which point all options become worthless anyway.
Finally, since you aren’t rolling over your contracts into new ones, your total profit potential is limited by how many contracts you bought initially.
While that may not seem like a big deal, especially if you bought several contracts right off the bat, it’s important to keep in mind that all of those premiums add up fast! One way around this is to use credit spreads instead of outright calls or puts.
While credit spreads take some of the edges off potential losses while still allowing for unlimited profit potential (provided implied volatility remains high), they can be quite complicated and require additional capital beyond what would otherwise be needed for a simple bull put spread or bear call spread.
What is the Maximum Loss?
Maximum loss is the difference between the ITM strike and the ATM strike, which happens when the price falls within this range.
For the example discussed above, max loss = 70 points [16500 (ATM) – 16300 (ITM) = 200 -130 (Net credit) =70]
= 70X 50 (lot size) = INR 3,500
What is the Maximum Profit?
There are no limits to what you can make if the price goes up enough - it could be millions of dollars or even billions.
The Bear Call Ladder or Short Call Ladder is best to use when you're sure of the move. This strategy has lower risks than traditional strategies and high returns in case of a significant move either way.