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Long Call Ladder Spread - Definition
An options strategy consisting of writing an additional higher strike price call option on a bull call spread in order to further reduce capital outlay.
Long Call Ladder Spread - Introduction
The Long Call Ladder Spread, also known as the Bull Call Ladder Spread, is an improvement made to an extremely popular options trading strategy, the Bull Call Spread. It further eliminates capital outlay by writing an additional further out of the money call option of the same expiration month. Such an improvement not only reduces capital outlay but sometimes eliminates capital outlay altogether, transforming the Bull Call Spread into a credit spread. The drawback of such an improvement is that the Long Call Ladder Spread is exposed to unlimited upside loss if the underlying stock moves explosively.
This tutorial shall explain what the Long Call Ladder Spread is, its calculations, pros and cons as well as how to profit from it.
Long Call Ladder Spread - Classification
Type of Strategy : Bullish
Type of Spread : Vertical Spread
Debit or Credit : Debit
The Long Call Ladder Spread is part of the "Ladder Spreads" family. Ladder Spreads add an additional further out of the money option on top of two legged spreads, stepping the position up by another strike price. The use of progressively higher or lower strike prices in a single spread gave "Ladder Spreads" its name.
Distinction Between Long Call Ladder Spread and Bull Ratio Spread
The Long Call Ladder Spread is extremely similiar to another options trading strategy, the Bull Ratio Spread. Both the Bull Ratio Spread and Long Call Ladder Spread aim to reduce or eliminate upfront capital outlay for a Bull Call Spread position. In doing so, both the Bull Ratio Spread and Long Call Ladder Spread require margin for the uncovered options. However, the Bull Ratio Spread does so by writing more out of the money call options at the same strike price while the Long Call Ladder Spread does so by writing call options at a higher strike price than the existing short call leg. The result of this difference is that the Long Call Ladder Spread require a lower margin than the Bull Ratio Spread due to the higher strike price of the additional short call options, while the Bull Ratio Spread would have a higher maximum profit, closer breakeven point and a lower capital outlay due to the higher extrinsic value offered by the lower strike price of the additional short call options.
When To Use Long Call Ladder Spread?
The Long Call Ladder Spread should be used as an improvement to a Bull Call Spread position when it is clear that the price of the underlying stock would not move explosively.
How To Use Long Call Ladder Spread?
Long Call Ladder is made up of buying an At The Money (or slightly ITM or OTM) Call Option, writing an equivalent amount of a higher strike price Out Of The Money Call Option and then writing yet another equivalent amount of an even higher strike price out of the money call option.
Buy ATM Call + Sell OTM Call + Sell Higher Strike OTM Call
Long Call Ladder Spread Example
Assuming QQQ trading at $44.
Buy To Open 1 contract of QQQ Jan44Call, Sell To Open 1 contract of QQQ Jan46Call and Sell To Open 1 contract of QQQ Jan47Call.
Choosing Strike Prices For Long Call Ladder Spread
The consideration behind the middle strike price for Long Call Ladder spreads is the same as the Bull Call Spread. You write the middle strike price call options at the price you expect the underlying stock to move up to but not exceed by expiration. In our example above, we expect QQQ to move up to but not exceed $46. If we expect QQQ to move up to $47 by expiration, we will write the middle strike price at $47 and then move the further OTM strike price higher as well.
The higher strike price OTM call is usually written one strike price higher than the middle strike price. In our example, since we wrote the middle strike price at $46, we have chosen to write the higher strike price OTM call one strike higher at $47. However, the higher the strike price of this highest strike price leg, the lower the margin requirement becomes as the extrinsic value of the position decreases. As such, one could also choose to write this highest strike price leg at as high a strike price as it takes to reduce the capital outlay of the position to a level of one's satisfaction.
Trading Level Required For Long Call Ladder Spread
A Level 5 options trading account that allows naked write is needed for the Long Call Ladder Spread due to the uncovered highest strike price leg. Read more about Options Account Trading Levels.
Profit Potential of Long Call Ladder Spread
Long Call Ladder Spread profits primarily when the price of the underlying stock increases up to and remains between the strike prices of the two short calls. The Long Call Ladder Spread would start to go into a loss when the price of the underlying stock increase beyond the strike price of the highest strike price call options. As such, it would be advisable to place a stop loss at the highest strike price call options using a contingent order to close out the whole position when the underlying stock reaches that strike price or to make an adjustment to the position to transform it into a more bullish options trading strategy when it is clear that the stock is going to rally explosively (see alternate actions before expiration below).
Profit Calculation of Long Call Ladder Spread
Maximum Profit = Middle strike price - Strike Price of Long Call - Net Debit Paid
Maximum Loss if Stock Falls = Net Debit
Maximum Loss if Stock Rallies Beyond Highest Strike Price = Unlimited
Long Call Ladder Spread Calculations
Following up on the above example, assuming QQQQ at $46.50 at expiration.
Bought the JAN 44 Call for $1.50
Wrote the JAN 46 Call for $0.50
Wrote the JAN 47 Call for $0.15
Net Debit = $1.50 - $0.50 - $0.15 = $0.85
Maximum Profit = 46 - 44 - 0.85 = $1.15
Reward Risk Ratio = 1.15 / 0.85 = 1.35
Max. Downside Risk = $0.85
Max. Upside Risk = Unlimited
Upper Break Even = $1.15 + $47 = $48.15
Lower Break Even = $44 + $0.85 = $44.85
Risk / Reward of Long Call Ladder Spread
Maximum Profit: Limited
Maximum Downside Loss: Limited to net debit paid
Maximum Upside Loss: Unlimited beyond highest strike price
Break Even Point of Long Call Ladder Spread
There are 2 break even points to a Long Call Ladder Spread. One breakeven point if the underlying asset goes up (Upper Breakeven) beyond which the position goes into an unlimited loss, and one breakeven
point if the underlying asset goes down (Lower Breakeven).
Upper BEP: Max. Profit + Highest Strike
Lower BEP: Long Call Strike Price + Net Debit Paid
Long Call Ladder Spread Greeks
Delta : Positive
Delta of Long Call Ladder Spread is positive at the start. As such, its value will increase as the price of the underlying stock increases.
Gamma : Negative
Gamma of Long Call Ladder Spread is negative and will reduce delta as the price of the underlying stock increases. It will then come to a point where the delta will become negative and the position will start to decline in value as the price of the underlying stock continues to increase.
Theta : Positive
Theta of Long Call Ladder Spread is positive and will therefore gain value over time due to time decay in the short term prior to expiration as the short out of the money call options lose value faster than the long call options.
Vega : Negative
Vega of Long Call Ladder Spread is negative and will therefore lose value as implied volatility rises and gains value as implied volatility drops. As such, it is highly disadvantageous to use a Long Call Ladder Spread in periods of rising implied volatility prior to expiration.
Advantages Of Long Call Ladder Spread
:: Further reduces capital outlay of a Bull Call Spread
:: Wider maximum profit zone than a Bull Ratio Spread
:: Lowers breakeven point of a Bull Call Spread
Disadvantages Of Long Call Ladder Spread
:: Margin required due to uncovered OTM leg
Adjustments for Long Call Ladder Spread Before Expiration
1. If the underlying asset has moved beyond its breakeven point and is expected to continue to move strongly in the same direction,
one could Buy To Close the short call options and hold the long call options for unlimited upside profit.