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Options strategy -Put & Call Ladder

The call ladder (long call ladder) is a limited profit, unlimited risk strategy in options trading that is employed when the investor thinks that the underlying will experience little volatility in the near term. To set up the long call ladder, the options trader purchases a call ITM (K1), sells a call ATM (K2), and sells another higher strike call OTM (K3) of the same underlying and same maturity. A Short Put Ladder is a strategy implemented when an investor is expecting high volatility in the near term. A short put ladder is built through the sale of an ITM put with K3 strike and the purchase of an ATM and OTM puts, K2 and K1 strike respectively.

The payoffs of both strategies are illustrated below:

The long call ladder can also be thought of an extension to the bull call spread by selling another higher striking call OTM. The purpose of writing 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, which could result in a significant loss at maturity. Maximum gain for the long call ladder strategy is limited and occurs when the underlying stock price on the expiration date is trading between the strike prices of the two call options sold. The ratio of ITM calls to ATM calls to OTM calls is 1:1:1. This strategy is implemented when the investor is anticipating low volatility in the near future. If on the contrary, the investor is anticipating huge volatility, he will implement a short call ladder, which is basically the opposite strategy. However, this strategy could, on the contrary of a short call ladder, could lead to unlimited losses, especially if the underlying price skyrocket. A short call ladder will expose the investor to unlimited potential profit and limited risk. Finally, a long call ladder is a delta, gamma, and vega negative while being theta positive (due to the two calls sold compared to the one bought).

The short put ladder, on the contrary, can be implemented in a bearish market as the maximum profit will occur if the underlying price fall under the strike of the put bought (K1). The delta of the short put ladder will approach -1 as the underlying price slip. On the contrary, the delta may become positive if the underlying price remains between K2 and K3 as expiry comes close. The gamma could be negative if the underlying price stays at strike K3. However, gamma will reach its maximum level if the underlying price remains between strikes K1 and K2. The theta could become positive if the underlying price approaches the K3 strike. However, as the strategy requires the purchase of two options, the theta is negative at inception and gets bigger as expiry approaches. Regarding the vega of the strategy, at inception, it will be positive as we long two options. Nevertheless, the vega may become negative if the underlying price stays at K3 strike when maturity approaches. This strategy is particularly interesting when an investor is expecting both high volatility and a downward move from the underlying price in the near term.

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