Option Strategies – Bear Call Ladder Strategy

Options Strategies – Bear Call Ladder Strategy ?

The word “Bear” in the “Bear Call Ladder” should not fool you into thinking it’s a bearish approach. The Bear Call Ladder is a variation on the Call ratio back spread; this plainly indicates that you use this method when you are 100% bullish on the stock or index.
The cost of purchasing call options is covered by selling a ‘in the money’ call option in a Bear Call Ladder. Furthermore, the Bear Call Ladder is frequently set up for a ‘net credit,’ which means that the cash flow is always better than the call ratio back spread’s cash flow. However, keep in mind that while each of these techniques have similar payoff structures, the risk structures differ slightly.

 

How to execute Bear Call Ladder Strategy ?

The Bear Call Ladder is a 3 leg option strategy, usually setup for a “net credit”. The 3 legs are

1. Selling 1 ITM call option
2. Buying 1 ATM call option
3. Buying 1 OTM call option

This is the classic Bear Call Ladder setup, executed in a 1:1:1 combination. The bear Call Ladder has to be executed in the 1:1:1 ratio meaning for every 1 ITM Call option sold then  1 ATM and 1 OTM Call option has to be bought. Other combination like 2:2:2 or 3:3:3 etc is possible.

 

Example of Nifty Bear Call Ladder Strategy ?

Spot is at 17790 and you expect Nifty to hit 18100 by the end of expiry. This clearly shows a bullish outlook on the market.

To Execute the Bear Call Ladder –

Sell 1 ITM Call option
Buy 1 ATM Call option
Buy 1 OTM Call option

All The Call options belong to the same expiry and belongs to the same underlying. The ratio must be maintained

The trade set up looks like this –17600 CE, one lot short, the premium received for this is Rs.257/-
17800 CE, one lot long, the premium paid for this option is Rs.127/-
17900 CE, one lot long, the premium paid for this option is Rs.80/-

The net credit would be 257-127-80 = 50

With these trades, the bear call ladder is executed.

Profit and Loss of the Bear Call Ladder Strategy ?

To evaluate the strategy payoff at various levels of expiry as the strategy payoff is quite versatile.

 

1 – Market expires at 17600

The 17600 call would have an intrinsic value of Zero [17600 – 17600]

Since we have sold this option, we get to retain the premium received i.e Rs.257/-

Likewise the intrinsic value of 17800 CE and 17900 CE would also be zero

So, we lose the premium paid i.e Rs.127 and Rs.80

Profit = Premium Received – Premium paid= 257 – 127 – 80 = 50

 

2 – Market expires at 17650

The 17600 CE we sold would have an intrinsic value of 50 [Spot – Strike]

Since the 17600 CE is short, we will lose 50 from 257 and retain the balance= 257 – 50 = 207

The 17800 and 17900 CE would expire worthless, hence we lose the premium paid i.e 127 and 80 respectively.

The total strategy payoff would be –= 207 – 127 – 80 = 0

For this strategy this is considered a lower breakeven point.

 

3 – Market expires at 17700

The intrinsic value of 17600 CE would be  100[spot – Strike]

Since, we have sold this option for 257 the net pay off from the option would be257 – 100

we have bought 17800 CE and 17900 CE where both of which would expire worthless.

So, we lose the premium paid for these options i.e 127 and 80 = 207 total

Net payoff from the strategy would be 157 – 127 – 80= – 50

 

4 – Market expires at 17800

The 17600 CE would have an intrinsic value of 200, we have written this option for a premium of Rs.257, we stand to lose the intrinsic value which is Rs.200 so total 257-200=57 .

Both 17800 CE and 17900 CE would expire worthless, hence the premium that we paid goes waste, i.e 127 and 80 respectively. Hence our total payoff would be 57 – 127 – 80=  -150 (More loss then above scenario)

5 – Market expires at 18040

Similar to the call ratio back spread, the bear call ladder has two breakeven points i.e the upper and lower breakeven. We evaluated the lower breakeven earlier (scenario 2), and this is the upper breakeven point.

Both 17900 and 17800 are strikes we are long on and 17600 is the strike we are short on.

50 is the net credit we had.

So at 18040, all the call options would have an intrinsic value  17600 CE would have an intrinsic value of 18050 – 17600 = 450, since we are short on this at 257, we stand to lose 257 – 450 = -193

CE would have an intrinsic value of 18050 – 17800 = 250 and we are long on this at 127 so 250 – 127 = +123

17900 CE would have an intrinsic value of 18050 –17900 = 150,we are long on this at 80 so 150 – 80 = +70

So this is upper breakeven point.

6 – Market expires at 18300

At 18300 all the call options would have an intrinsic value.

17600 CE would have an intrinsic value of 18300 – 17600 = 700 and we are short on this at 257, we stand to lose 257 – 700 = -443

17800 CE would have an intrinsic value of 18300 – 17800 = 500 and we are long on this at 127, we make 500 – 127 = +373

17900 CE would have an intrinsic value of 18300 – 17900 = 400 and we are long on this at 80, we make 400 – 80 = +320

Hence the total payoff from the Bear Call Ladder = –260260

The higher the market move, the higher is the profit potential.

When the market moves up the profits are uncapped or unlimited.

 

Short Summary of Bear Call Ladder Strategy ?

Net Credit = Premium Received from ITM CE – Premium paid to ATM & OTM CE
Max Loss = Spread (difference between the ITM and ITM options) – Net Credit
Max Loss occurs at = ATM and OTM Strike
The payoff when market goes down = Net Credit
Lower Breakeven = Lower Strike + Net Credit
Upper Breakeven = Sum of Long strike minus short strike minus net premium