Long Put Ladder Spread

How Does Put Ladder Spreads Work in Options Trading?

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Long Put Ladder Spread - Definition

An options strategy consisting of writing an additional lower strike price put option on a bear put spread in order to further reduce capital outlay.

Long Put Ladder Spread - Introduction

The Long Put Ladder Spread, also known as the Bear Put Ladder Spread, is an improvement made to the Bear Put Spread. It further eliminates capital outlay by writing an additional further out of the money put option of the same expiration month. Such an improvement not only reduces capital outlay but sometimes eliminates capital outlay altogether, transforming the Bear Put Spread into a credit spread. The drawback of such an improvement is that the Long Put Ladder Spread is exposed to unlimited upside loss if the underlying stock moves downwards explosively. Yes, there are always pros and cons to every options trading strategy.

This tutorial shall explain what the Long Put Ladder Spread is, its calculations, pros and cons as well as how to profit from it.

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Long Put Ladder Spread - Classification

Type of Strategy : Bearish | Type of Spread : Vertical Spread | Debit or Credit : Debit

The Long Put 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 down 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 Put Ladder Spread and Bear Ratio Spread

The Long Put Ladder Spread is extremely similiar to the Bear Ratio Spread as both the Bear Ratio Spread and Long Put Ladder Spread aim to reduce or eliminate upfront capital outlay for a Bear Put Spread position. In doing so, both the Bear Ratio Spread and Long Put Ladder Spread require margin for the uncovered options. However, the Bear Ratio Spread does so by writing more out of the money put options at the same strike price while the Long Put Ladder Spread does so by writing put options at a lower strike price than the existing short put leg. The result of this difference is that the Long Put Ladder Spread require a lower margin than the Bear Ratio Spread due to the lower strike price of the additional short put options, while the Bear 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 higher strike price of the additional short put options.

When To Use Long Put Ladder Spread?

The Long Put Ladder Spread should be used as an improvement to a Bear Put Spread position when it is clear that the price of the underlying stock would not move explosively.

How To Use Long Put Ladder Spread?

Long Put Ladder is made up of buying an At The Money (or slightly ITM or OTM) Put Option, writing an equivalent amount of a lower strike price Out Of The Money put Option and then writing yet another equivalent amount of an even lower strike price out of the money put option.

Buy ATM Put + Sell OTM Put + Sell Lower Strike OTM Put

Long Put Ladder Spread Example Assuming QQQ trading at $44. Buy To Open 1 contract of QQQ Jan44Put, Sell To Open 1 contract of QQQ Jan42Put and Sell To Open 1 contract of QQQ Jan41Put.

Choosing Strike Prices For Long Put Ladder Spread

The consideration behind the middle strike price for Long Put Ladder spreads is the same as the Bear Put Spread. You write the middle strike price put options at the price you expect the underlying stock to move down to but not exceed by expiration. In our example above, we expect QQQ to move down to but not exceed $42. If we expect QQQ to move down to $41 by expiration, we will write the middle strike price at $41 and then move the further OTM strike price lower as well.

The lower strike price OTM put is usually written one strike price lower than the middle strike price. In our example, since we wrote the middle strike price at $42, we have chosen to write the lower strike price OTM put one strike lower at $41. However, the lower the strike price of this lowest strike price leg, the lower the margin requirement. As such, one could also choose to write this lowest strike price leg at as low 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 Put Ladder Spread

A Level 5 options trading account that allows naked write is needed for the Long Put Ladder Spread due to the uncovered lowest strike price leg. Read more about Options Account Trading Levels.

Profit Potential of Long Put Ladder Spread

Long Put Ladder Spread profits primarily when the price of the underlying stock decreases to and remains between the strike prices of the two short puts. The Long Put Ladder Spread would start losing money when the price of the underlying stock decrease beyond the strike price of the lowest strike price put options. As such, it would be advisable to place a stop loss at the lowest strike price put options using a contingent order in 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 bearish options trading strategy when it is clear that the stock is going to drop drastically (see alternate actions before expiration below).

Profit Calculation of Long Put Ladder Spread

Maximum Profit = Strike Price of Long Put - Middle Strike Price - Net Debit Paid

Maximum Loss if Stock Rises = Net Debit

Maximum Loss if Stock Drops Beyond Lowest Strike Price = Unlimited

Long Put Ladder Spread Calculations Following up on the above example, assuming QQQQ at $46.50 at expiration. Bought the JAN 44 Put for $1.50 Wrote the JAN 42 Put for $0.50 Wrote the JAN 41 Put for $0.15 Net Debit = $1.50 - $0.50 - $0.15 = $0.85 Maximum Profit = 44 - 42 - 0.85 = $1.15 Reward Risk Ratio = 1.15 / 0.85 = 1.35 Max. Upside Risk = $0.85 Max. Downside Risk = Unlimited Upper Break Even = $44 - $0.85 = $43.15 Lower Break Even = $41 - $1.15 = $39.85

Risk / Reward of Long Put Ladder Spread

Maximum Profit: Limited

Maximum Upside Loss: Limited to net debit paid

Maximum Downside Loss: Unlimited beyond lowest strike price

Break Even Point of Long Put Ladder Spread

There are 2 break even points to a Long Put 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: Long Put Strike - Net Debit
Lower BEP: Lowest Strike - Max. Profit

Long Put Ladder Spread Greeks

Delta : Negative
Delta of Long Put Ladder Spread is negative at the start. As such, its value will increase as the price of the underlying stock decreases.

Gamma : Negative
Gamma of Long Put Ladder Spread is negative and will increase delta as the price of the underlying stock decreases. It will then come to a point where the delta will become positive and the position will start to decline in value as the price of the underlying stock continues to decrease.

Theta : Positive
Theta of Long Put 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 put options lose value faster than the Long Put options.

Vega : Negative
Vega of Long Put 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 Put Ladder Spread in periods of rising implied volatility prior to expiration.

Advantages Of Long Put Ladder Spread

:: Further reduces capital outlay of a Bear Put Spread

:: Wider maximum profit zone than a Bear Ratio Spread

:: Lowers breakeven point of a Bear Put Spread

Disadvantages Of Long Put Ladder Spread

:: Margin required due to uncovered OTM leg

Adjustments for Long Put Ladder Spread Before Expiration

1. If the underlying asset has declined beyond its breakeven point and is expected to continue to move strongly in the same direction, one could Buy To Close the short put options and hold the Long Put options for unlimited downside profit.

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