Short Call Ladder Options Strategy
A Short Call Ladder Strategy is not a bearish strategy. It is an upgraded call ratio back spread or bear call spread. This strategy is implemented when someone is outwardly bullish on the underlying asset. Unlimited profits on the upside and limited profit on the downside is the payoff in Short Call Ladder Strategy.
If the underlying asset doesn’t show a significant move on either side, the strategy makes a limited loss. The cost of call options is financed by selling an In The Money (ITM) Calls Options. The setup gives a ‘net credit’ that is a cash-in strategy. In simple words, this strategy consists of buying 1 ATM call and 1 OTM Call of the same underlying asset and selling an ITM call, all with the same expiry.
What is the Short Call Ladder Options Strategy?
This is an options strategy consisting of buying an additional higher strike price call option and an at-the-money call option and financing them through selling in-the-money call options in evenly distributed quantities. Let’s simplify this with an example.
This is a Net Credit strategy that involves –
- Buying 1 ATM Strike Call Options
- Buying 1 OTM Strike Call Options
- Selling 1 ITM Strike Call Options
This setup is executed in a 1:1:1 combination. This means an ATM and OTM call must be bought for every 1 ITM call selling options.
When to Initiate Short Call Ladder Options Strategy?
This strategy can be initiated when a trader expects a significant price move in the underlying asset. The movement can be scheduled upward or downward but not in a range-bound direction. Profitability will be unlimited when stock breaks the highest strike price. There will also be an opportunity when the stock’s implied volatility falls significantly. This strategy will give good results when the implied volatility spikes.
How to Use a Short Call Ladder Options Strategy?
The tables below show the options chain of the Nifty50 Index; with its help, a trader can select option’s strike for the strategy.
This first table is showing Call Options strikes at different levels of the Nifty50 Index.
- Strike price of Nifty 50 Index is in the first column, strike means levels of Nifty 50; here, a trader can choose from the given strike based upon his/her strategy.
- Second column shows a change in the premium of that strike until yesterday’s closing.
- Bid Quantity is represented by a third column showing the total quantity of options contract offered by the buyers.
- Ask Quantity in the fourth column is showing the total quantity offered for selling by sellers.
- Fifth column shows the BID rate, which means buyers are ready to buy at that price.
- Sixth column shows ASK rate, price at which sellers are ready to sell.
- Last column shows Last Traded Price(LTP), the price at which options are traded.
Here, the table has highlighted the different aspects of Put Options strikes:
- Strike prices are in the first column
- Last traded price of put options at different strikes are in the second column.
- Bid rate is the price at which the buyers want to buy puts.
- Ask rate is the price at which sellers want to sell puts
- Bid qty is the total number of put contracts open for buying at different strikes.
- Ask qty is the total number of put contracts open for selling at different strikes.
- Change in price of puts today till yesterday’s closing is shown in the last column.
Objective of this strategy is that the underlying will make a significant move on either side. The zone marked in yellow shows ITM options strikes of both calls and puts as shown in the tables above, 17800 is for at the money (ATM), 17850 for out-of-the-money (OTM) and below 17700 are in-the-money options (ITM) on the call side.
In Put side, 17700 is At the money strike (ATM), 17800 is In the money (ITM), and 17650 is out of the money.
In simple words, the options that are In the money on the call side become out of the money on the outside and In the money put options are considered as out-of-the-money Call options. The price in between at which the underlying Nifty50 trades becomes ATM.
Choosing Strike Price
Referring to options chain table, buying an ATM strike option from call side, i.e. 17800 trading at ₹65.60, an OTM option with strike of 17850 at ₹47.90 and ITM option with strike price of ₹17650 at ₹88.30 in the ratio of 1:1:1 will build this strategy.
A significant spike in volatility with an upward price movement in the Nifty50 Index will open up unlimited profit potential in this strategy. Option strike ₹17800 and ₹17850 will gain from this transaction, while the sold ITM option will make some loss.
This loss will get covered up with a gradual upward trajectory in Nifty50. If the volatility starts falling, it is advisable to book the profit and close all the positions in this strategy. This strategy will give limited profit if the Index price starts to fall.
The above image shows the payoff graph for short call ladder; horizontal line depicts the movement of price in the Index, and vertical line is the amount of profit projectable. Here x1 denotes that if Nifty goes below 17700, profitability zone will be limited as the ITM option will get sold at 17650; x2 represents position of ATM strike at 17800, x3 is the position of OTM strike at 17850 and PR1 and PR2 show the break even.
The lower break-even PR1 is the strike price of the short call + net premium received. Upper break even PR 2 is the higher long call strike price + strike difference between short call and lower long call-net premium received.
- This strategy’s risk is lower and limited when compared to profits.
- The strategy tends to fail if the market does not move significantly.
- Time value of long ATM and OTM options decrease, and the strategy may fail nearing expiry.
- A trader must book profit if the market moves higher significantly with the rise in volatility.
- Volatility is a key factor while implementing this strategy, as increasing volatility results in a rise in options prices. As volatility decreases, the options price tends to fall.
- This strategy should not be kept on hold till expiry date.
The break-even of this strategy is calculated by adding the premium paid to buy the long calls and subtracting the ITM sell + net premium received.
Let’s discuss this with an example:
Premium paid for buying 17800 strike = ₹65.60
Premium paid for Buying 17850 strike = ₹47.90
Premium obtained Selling 17650 strike = ₹88.30
(₹65.60 + ₹47.90 – ₹88.30) = ₹25.20 + Premium Received (₹88.30)
Break even on the upper side is 17800 + ₹88.30 = 17888.30
Lower Break Even = Strike Price of Short Call ₹88.30 – Net Premium Received ₹25.20
= ₹63.10, 17650 – ₹63.10
The break-even in this strategy is between 17586 on the lower side to 17888 on the upper side.
Analysis of Short Call Ladder Options Strategy
The short call option is the ITM option in this strategy and possesses the highest intrinsic value, which won’t be affected by time decay nearing the expiry day. Conversely, ATM and OTM long calls will face time decay, and their premium will lose their worth faster near expiry.
However, theta (time value) affects the profitability of this strategy and works against it. Therefore, in a short call ladder spread, the position must be closed one or two days before expiry date if the target is not met.
Successful implementation of the short call ladder strategy requires an intensive overview of market scenarios. The techniques to be followed while using this strategy depends on the underlying price movement.
This strategy comes with limited loss and unlimited profitability potential unless the markets are on a sideways trajectory. Volatility in the underlying assets works in favour of this strategy. This strategy and the features covered under it will help you make a confident decision while trading options.
Frequently Asked Questions
Under which condition does the Short Call Ladder Options Strategy work?
When volatility is high, the price of call options go higher. A trader should expect a significant price movement on the upside or downside in this situation and implement the Short Call Ladder Options strategy.
What is the limitation of Short Call Ladder Options Strategy?
This strategy only works when the volatility is high, and in typical market scenarios, it tends to fail.
What is the primary advantage of using the Short Call Ladder Options Strategy?
With Short Call Ladder Options Strategy, the key advantage is limited risk and buying or selling of naked call options at a more reasonable rate, which requires a lot of margin.
Is the short-call ladder options strategy profitable?
A short-call ladder options strategy is profitable if the market is bullish. The profitability is unlimited once it breaks the upper break even point.