Short Put Ladder Options Strategy
Short Put Ladder is a mix of bullish and bearish strategies. This three-legged options strategy includes unlimited profit on the downside and limited on the upside after breaching a particular price level.
Risk is limited in short put ladder. It is built by selling an In The Money (ITM) put option, buying an At The Money (ATM) put option and buying one Out of The Money (OTM) put option.
Underlying asset’s price must fall significantly to make this strategy profitable. At the same time, the potential loss is limited when the price trades between a range. It will gain to a limited extent irrespective of higher price movement in the underlying asset.
What is the Short Put Ladder Options Strategy?
Short Put Ladder is a combination of three put options of different strikes having the same expiration date. To build a Short Put Ladder, traders need to sell an ITM put option of a higher strike price, buy an ATM put option and a lower strike price OTM put option.
This becomes a net credit put spread through selling a higher priced ITM put strike; bought ATM and OTM puts are cheaper as they have no intrinsic value, containing only time value.
When to Initiate a Short Put Ladder Options Strategy?
A Short Put Ladder should be initiated when a trader expects a significant downward price move in the underlying asset. Profit potential will become unlimited if the price breaks the lower strike price of a bought option. This strategy is also beneficial when the implied volatility of underlying is expected to rise.
How to use Short Put Ladder Strategy and Choose Option Strike Price?
One can understand how to build a Short Put Ladder by assessing the strike options in the table below. The underlying asset here is Nifty50 Index, and the table below shows its put options price at different strike levels.
Assuming the Nifty50 index is trading at 17800, and 17800 is the ATM option:
|Strike Price||Options Price||Types of Options|
|17650||₹25||Out of the Money|
|17700||₹60||Out of the Money|
|17750||₹100||Out of the Money|
|17800||₹150||At The Money|
|17850||₹280||In the Money|
|17900||₹350||In the Money|
|17950||₹400||In the Money|
Strategy: Short Put Ladder Options
Strikes for trade: Strike 1. 17850 PUT (ITM)
Strike 2. 17800 PUT (ATM)
Strike 3. 17750 PUT (OTM)
Action for Trade: Sell 1 Quantity ITM Put ₹280 (+)
Buy 1 Quantity ATM Put ₹150 (-)
Buy 1 Quantity OTM Put ₹100 (-)
Positive, and negative signs denote inflows and outflows of premiums.
Calculation of net premium received and paid below
Total Premium Paid = ₹(150 + 100)
Total Premium Received = ₹(280 – 250)
Short Put Ladder will offer maximum profit if the Nifty 50 index breaks below 17750. It will face maximum loss if Nifty50 trades between a range of two bought puts of 17750 and 17800 till expirations.
These OTM and ATM strikes will lose their value while approaching expiry. If Nifty50 makes a significant move on the upside, it will have limited profit beyond the 17850 level.
The diagram above shows payoff structure of Short Put Ladder, vertical axis showing the amount of profit/loss and a horizontal axis showing price change in underlying till expiration.
Let’s analyse the payoff diagram concerning the strike price selected for strategy.
- Short Put Option with strike price of 17850 (ITM)
- Long Put Option with strike price of 17800 (ATM)
- Long Put Option with strike price of 17750 (OTM)
This strategy will lead to unlimited profits if it breaks lower breakeven point and underlying assets Nifty50 moves downwards.
It will face a maximum limited loss if Nifty 50 trades between 17800 and 17750.
Long Put Ladder will give limited profits if it breaks the upper band of breakeven.
- Short Put Ladder has a mix of limited and unlimited profit and a limited risk payoff structure.
- The strategy remains profitable when the market is volatile with an underlying high-frequency price movement.
- Maximum reward is limited in upside through sold put options and the strategy becomes unprofitable if the price keeps moving in the range of two bought call options.
- Maximum loss is limited; it is advisable to trade if the price is trading in a narrow range and has the potential to break out in either direction.
- To increase the profit probability of this strategy, a trader must choose a narrow distance strike between two bought put options.
Break Even Point
Assuming Nifty50 is trading at 17800, the breakeven points of the strategy have been calculated below:
Upper Breakeven = ₹(Sold ITM PUT – Net Premium Received)
= ₹(17850 – 30)
The strategy’s upper breakeven level is 17830, and if Nifty50 breaks this level, the profit will become limited on the upside.
Lower breakeven = ₹(Bought OTM PUT + Bought ATM PUT – Sold ITM PUT + Net premium received)
= ₹(17750 + 17800 – 17850 + 30)
The strategy’s lower breakeven level is 17730. If Nifty50 goes below this level, a strategy will lead to unlimited profit potential.
Maximum potential profit on Downside = Unlimited
Maximum potential profit on Upside = (Net Premium Received)* Lot size
Maximum Loss = (Sold ITM PUT 17850 – Bought ATM PUT 17800 – Net premium received)*Lot size
= ₹(17850 – 17800 – 30)*50
Analysis of Short Put Ladder Options Strategy
Short Put Ladder is a negative delta strategy, which indicates an exponentially higher profit if the underlying asset moves towards lower price levels.
Vega in this strategy will show positive; the spread will benefit from an increase in volatility, and the best opportunity will arise when the price is trading in a narrow range and about to move in either direction.
Theta has a negative impact on this strategy, which indicates short-put ladder options will lose value while approaching expiry.
The gamma effect will be positive in this strategy; a significant downward movement in price will lead to profit.
Short Put Ladder is an exemplary strategy to use when markets are trading in a narrow range. This strategy has more potential to profit from downward directional movement. It demands a sudden spike in volatility before the expiration of options contracts.
The strategy won’t be able to fructify if underlying assets don’t make any significant move on either side. Though this strategy comes with limited risk, keeping a narrow gap between strikes is preferable.
When options prices are low, the underlying asset makes a narrow-range price action. You may also consider making adjustments to your positions based on changing market conditions. For example, you could roll up the sold put option to a higher strike price to reduce risk or close out specific legs of the strategy while keeping others open.
It’s important to evaluate your exit strategy based on your individual circumstances, investment goals, and risk tolerance.
Frequently Asked Questions
What is a multi-legged options strategy?
A multi-legged options strategy consists of buying and selling different options at different strike prices. These strategies are used to take advantage of certain market conditions.
What is the best possible market scenario for Short Put Ladder?
When markets trade in a narrow zone of price movement, the volatility can rise, along with a downward movement of the underlying asset’s price.
What are the advantages of Short Put Ladder?
This strategy includes selling one put option and buying two put options. There is unlimited profit on the downside, limited profit on the upside and carries limited risk when the price is rangebound.
What are the drawbacks of Short Put Ladder?
If underlying assets don’t move beyond two breakeven points, the strategy will make a loss. This strategy can become a debit spread if option prices are too high and implied volatility is too high.