Long Call Ladder Explained

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Contents

Ladder Option

What Is a Ladder Option?

A ladder option is an exotic option that locks in partial profits once the underlying asset reaches predetermined price levels or “rungs.” This guarantees at least some profit, even if the underlying asset retraces beyond these levels before the option expires. Ladder options come in put and call varieties.

Do not confuse ladder options, which are specific types of options contracts, with long call ladders, long put ladders, and their short counterparts, which are options strategies that involve buying and selling multiple options contracts simultaneously.

How a Ladder Option Works

Ladder options are similar to traditional option contracts that give the holder the right, but not the obligation to buy or sell the underlying asset at a predetermined price at or by a predetermined date. However, a ladder option adds a feature that allows the holder to lock in partial profits at predetermined intervals.

These intervals are fittingly called “rungs” and the more rungs the price of the underlying asset crosses, the more profit locks in. The holder keeps profits based on the highest rung achieved (for calls) or the lowest rung achieved (for puts) regardless if the price of the underlying crosses back below (for calls) or above (for puts) those rungs before expiration.

Because the holder earns non-returnable partial profits as the trade develops, total risk is much lower than for traditional vanilla options. The trade-off, of course, is that ladder options are more expensive than similar vanilla options.

Example of a Ladder Option

Consider a ladder call option where the underlying asset price is 50 and the strike price is 55. Rungs are set at 60, 65, and 70. If the underlying price reaches 62, the profit locks in at 5 (rung minus strike or 60 – 55). If the underlying reaches 71, then the locked in profit increases to 15 (new rung minus strike or 70 – 55), even if the underlying falls below these levels before the expiration date.

As with vanilla options, there is time value associated with ladder options. Therefore, the traded price for call options is usually above the locked in profit amount, and declining as the expiration date approaches.

If the price of the underlying falls below any of the triggered rungs, again for calls, it almost does not matter to the price of the option because the partial profit is guaranteed. Although, this is an oversimplification because the lower the underlying moves below the highest triggered rung, the less likely it will be to rally back to exceed that rung and reach the next rung.

Bear Call Ladder Options Trading Strategy In Python

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.

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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:

Options Selection

  • 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

Execution

  • 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

Risk

Trader or investor buys more calls than they are selling, therefore, Limited Max. Risk

Breakeven

  • 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

Expiration

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

Live Example

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.

Python Code For Bear Call Ladder Strategy

Import Library

Calculate Payoff

Long Call 1 Payoff

Long Call 2 Payoff

Short Call Payoff

Bear Call Ladder Payoff

Bear Call Ladder

Conclusion

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.

Next Step

Are you keen on learning more about algorithmic trading? Connect with us and get to know different worldviews on financial strategies. QuantInsti® aids people in acquiring skill sets which can be applied across various trading instruments and platforms. The Executive Programme in Algorithmic Trading (EPAT™) course covers training modules like Statistics & Econometrics, Financial Computing & Technology, and Algorithmic & Quantitative Trading. EPAT™ equips you with the required skill sets to be a successful trader. 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.

Long Call Options Trading Strategy Explained

Published on Tuesday, April 17, 2020 | Modified on Wednesday, June 5, 2020

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Long Call Options Strategy

Strategy Level Beginners
Instruments Traded Call
Number of Positions 1
Market View Bullish
Risk Profile Limited
Reward Profile Unlimited
Breakeven Point Strike Price + Premium

A Long Call Option trading strategy is one of the basic strategies. In this strategy, a trader is Bullish in his market view and expects the market to rise in near future. The strategy involves taking a single position of buying a Call Option (either ITM, ATM or OTM). This strategy has limited risk (max loss is premium paid) and unlimited profit potential.

When the trader goes long on call, the trader buys a Call Option and later sells it to earn profits if the price of the underlying asset goes up.

When the trader buys a call, he pays the option premium in exchange for the right (but not the obligation) to buy share or index at a fixed price by a certain expiry date. This premium is the only amount at-the-risk for trader in case the market moves in other direction (price of underlying asset falls).

In this strategy, we first buy a call and then close out the position later. This strategy should not be confused with ‘Naked Call’ where we sell calls and then buy them back at a cheaper price.

When to use Long Call strategy?

A long call Option strategy works well when you expect the underlying instrument to move positively in the recent future.

If you expect XYZ company to do well in near future then you can buy Call Options of the company. You will earn the profit if the price of the company shares closes above the Strike Price on the expiry date. However, if underlying shares don’t do well and move downwards on expiry date you will incur losses (i.e. lose premium paid).

Example

Example 1 – Bank Nifty

Buy 1 Call Option of Bank Nifty
Bank Nifty Spot Price в‚№ 8900
Lot Size: 1 contract = 25 Strike Price в‚№ 8800
Premium в‚№ 500
Breakeven в‚№
(Strike Price + Premium)
9300
Scenarios
Bank Nifty on expiry в‚№ Premium Pay-off в‚№
(Premium * Lot Size)
Exercise Pay-off в‚№
(Expiry Price – Strike Price) * Lot Size
Net Pay-off в‚№
(Exercise + Premium Payoff)
8800 -12500 0 -12500
9000 -12500 5000 -7500
9200 -12500 10000 – 2500
9400 -12500 15000 2500
9600 -12500 20000 7500

Example 2 – NIFTY OPTIONS

Suppose you are bullish on Nifty today when the Nifty is trading at 10, 550. You can implement a long call strategy by buying a call option with a strike price of 10,750 at a premium of в‚№40. If the Nifty goes above 10,790, you will make a net profit on exercising the option. In case the Nifty stays at or falls below 10,750, you will make a maximum loss of the premium paid.

Buy 1 Call Option of Nifty

Current Nifty в‚№10,550
Strike Price of Call Option в‚№10,750
Premium Paid 40 X 75= в‚№ 3000
Break Even Point (Strike Price + Premium) в‚№10,790
Lot Size 75
Long Call Strategy Payoff Schedule
Nifty on Expiry (в‚№) Net Payoff (в‚№)
(Strike Price – Break Even Point) * Lot Size
10,200 -3000.00
10,300 -3000.00
10,400 -3000.00
10,500 -3000.00
10,600 -3000.00
10,790 0.00
10,800 750.00
10,900 8,250.00
11,000 15,750.00

Note: Break Even Point is 10,790. The maximum loss cannot be greater than в‚№40 premium paid.

Market View – Bullish

When you’re expecting a rise in the price of the underlying and increase in volatility.

Actions

  • Buy Call Option

A long call strategy involves buying a call option only. So if you expect Reliance to do well in near future then you can buy Call Options of Reliance. You will earn a profit if the price of Reliance shares closes above the Strike price on the expiry date. However, if Reliance shares don’t move up within the expiry date you will incur losses.

Breakeven Point

Strike Price + Premium

The break-even point for Long Call strategy is the sum of the strike price and premium paid. Traders earn profits if the price of the underlying asset moves above the break-even point. Traders loose premium if the price of the underlying asset falls below the break-even point.

Risk Profile of Long Call

Limited

The risk is limited to the premium paid for the call option irrespective of the price of the underlying on the expiration date.

Reward Profile of Long Call

Unlimited

There is no limit to maximum profit attainable in the long call option strategy. The trade gets profitable when price of the underlying is greater than strike price plus premium.

Profit = Price of Underlying – (Strike Price + Premium Paid)

Max Profit Scenario of Long Call

Underlying closes above the strike price on expiry.

Max Loss Scenario of Long Call

Underlying closes below the strike price on expiry.

Advantage of Long Call

Buying a Call Option instead of the underlying allows you to gain more profits by investing less and limiting your losses to minimum.

Disadvantage of Long Call

Call options have a limited lifespan. So, in case the price of your underlying stock is not higher than the strike price before the expiry date, the call option will expire worthlessly and you will lose the premium paid.

How to exit?

  • Sell the Call on profit before expiry
  • Wait for the Call to expire
  • Exercise the Call to buy the underlying

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Long Call Spread

AKA Bull Call Spread; Vertical Spread

The Strategy

A long call spread gives you the right to buy stock at strike price A and obligates you to sell the stock at strike price B if assigned.

This strategy is an alternative to buying a long call. Selling a cheaper call with higher-strike B helps to offset the cost of the call you buy at strike A. That ultimately limits your risk. The bad news is, to get the reduction in risk, you’re going to have to sacrifice some potential profit.

Options Guy’s Tips

Because you’re both buying and selling a call, the potential effect of a decrease in implied volatility will be somewhat neutralized.

The maximum value of a long call spread is usually achieved when it’s close to expiration. If you choose to close your position prior to expiration, you’ll want as little time value as possible remaining on the call you sold. You may wish to consider buying a shorter-term long call spread, e.g. 30-45 days from expiration.

The Setup

  • Buy a call, strike price A
  • Sell a call, strike price B
  • Generally, the stock will be at or above strike A and below strike B

NOTE: Both options have the same expiration month.

Who Should Run It

Veterans and higher

When to Run It

You’re bullish, but you have an upside target.

Break-even at Expiration

Strike A plus net debit paid.

The Sweet Spot

You want the stock to be at or above strike B at expiration, but not so far that you’re disappointed you didn’t simply buy a call on the underlying stock. But look on the bright side if that does happen — you played it smart and made a profit, and that’s always a good thing.

Maximum Potential Profit

Potential profit is limited to the difference between strike A and strike B minus the net debit paid.

Maximum Potential Loss

Risk is limited to the net debit paid.

Ally Invest Margin Requirement

After the trade is paid for, no additional margin is required.

As Time Goes By

For this strategy, the net effect of time decay is somewhat neutral. It’s eroding the value of the option you purchased (bad) and the option you sold (good).

Implied Volatility

After the strategy is established, the effect of implied volatility depends on where the stock is relative to your strike prices.

If your forecast was correct and the stock price is approaching or above strike B, you want implied volatility to decrease. That’s because it will decrease the value of the near-the-money option you sold faster than the in-the-money option you bought, thereby increasing the overall value of the spread.

If your forecast was incorrect and the stock price is approaching or below strike A, you want implied volatility to increase for two reasons. First, it will increase the value of the option you bought faster than the out-of-the-money option you sold, thereby increasing the overall value of the spread. Second, it reflects an increased probability of a price swing (which will hopefully be to the upside).

Check your strategy with Ally Invest tools

  • Use the Profit + Loss Calculator to establish break-even points, evaluate how your strategy might change as expiration approaches, and analyze the Option Greeks.
  • Use the Technical Analysis Tool to look for bullish indicators.

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