The long put ladder, or bear put ladder, is a limited profit, unlimited risk strategy in options trading that is employed when the options trader thinks that the underlying security will experience little volatility in the near term. To setup the long put ladder, the options trader purchases an in-the-money put, sells an at-the-money put and sells another lower strike out-of-the-money put of the same underlying security and expiration date.
|Long Put Ladder Construction|
|Buy 1 ITM Put|
Sell 1 ATM Put
Sell 1 OTM Put
The long put ladder can also be seen as an extension of the bear put spread by selling another lower striking put. The purpose of shorting another put 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 crashes.
Maximum profit for the long put ladder strategy is limited and occurs when the underlying stock price on expiration date is trading between the strike prices of the put options sold. At this price, while both the long put and the higher strike short put expire in the money, the long put is worth more than the short put. The profit can be calculated using the formula below.
The formula for calculating maximum profit is given below:
Losses is limited to the initial debit taken if the stock price rallies above the upper breakeven point but large unlimited losses can be suffered should the stock price makes a dramatic move to the downside below the lower breakeven point.
The formula for calculating loss is given below:
There are 2 break-even points for the long put ladder position. The breakeven points can be calculated using the following formulae.
Suppose XYZ stock is trading at $40 in June. An options trader executes a long put ladder strategy by buying a JUL 45 put for $600, selling a JUL 40 put for $200 and a JUL 35 put for $100. The net debit required for entering this trade is $300.
Let's say XYZ stock remains at $40 on expiration date. At this price, only the long JUL 45 put will expire in the money with an intrinsic value of $500. Taking into account the initial debit of $300, selling this put to close the position will give the trader a $200 profit - which is also his maximum possible profit.
In the event that XYZ stock rallies and is trading at $45 on expiration in July, all the puts will expire worthless and the trader's loss will be the initial $300 debit taken to enter the trade.
However, if the stock price had dropped to $25 instead, all the put options will expire in the money. The short JUL 40 put will expire with $1500 in intrinsic value while the short JUL 35 put will expire with $1000 in intrinsic value. Selling the long JUL 45 put will only give the options trader $2000 so he still have to top up another $500 to close the position. Together with the initial debit of $300, his total loss comes to $800. This loss could have been worse if the stock had dived below $25.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the long put ladder in that they are also low volatility strategies that have limited profit potential and unlimited risk.
The converse strategy to the long put ladder is the short put ladder. Short put ladders are employed when substantial movement is expected of the underlying stock price.
Your new trading account is immediately funded with $5,000 of virtual money which you can use to test out your trading strategies using OptionHouse's virtual trading platform without risking hard-earned money.
Once you start trading for real, your first 100 trades will be commission-free! (Make sure you click thru the link below and quote the promo code '60FREE' during sign-up)Click here to open a trading account at OptionsHouse.com now!
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]
If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]
Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time.....[Read on...]
If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®.... [Read on...]
Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]
As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]
Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]
To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]
Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]
Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]
Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]
Risk Warning: Stocks, futures and binary options trading discussed on this website can be considered High-Risk Trading Operations and their execution can be very risky and may result in significant losses or even in a total loss of all funds on your account. You should not risk more than you afford to lose. Before deciding to trade, you need to ensure that you understand the risks involved taking into account your investment objectives and level of experience. Information on this website is provided strictly for informational and educational purposes only and is not intended as a trading recommendation service. TheOptionsGuide.com shall not be liable for any errors, omissions, or delays in the content, or for any actions taken in reliance thereon.