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Short Call Ladder Spread - Definition
An options strategy consisting of buying an additional higher strike price call option on a bear call spread in order to transform the position from a bearish strategy to a volatile strategy.
Short Call Ladder Spread - Introduction
The Short Call Ladder Spread, also known as the Bear Call Ladder Spread, is an improvement to the Bear Call Spread, transforming it from an options strategy that profits only when the underlying stock goes downwards into a volatile strategy that profits when the underlying stock goes upwards or downwards with unlimited profit potential to upside.
This tutorial shall explain what the Short Call Ladder Spread is, its calculations, pros and cons as well as how to profit from it.
Short Call Ladder Spread - Classification
Type of Strategy : Volatile
Type of Spread : Vertical Spread
Debit or Credit : Credit
The Short 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.
When To Use Short Call Ladder Spread?
The Short Call Ladder Spread could be used when the price of the underlying stock is expected to remain stagnant, drop moderately or rally significantly.
How To Use Short Call Ladder Spread?
Short Call Ladder is made up of writing an At The Money Call Option, buying an equivalent amount of a higher strike price Out Of The Money Call Option and then buying yet another equivalent amount of an even higher strike price out of the money call option.
Sell ATM Call + Buy OTM Call + Buy Higher Strike OTM Call
Short Call Ladder Spread Example
Assuming QQQ trading at $44.
Sell To Open 1 contract of QQQ Jan44Call, Buy To Open 1 contract of QQQ Jan46Call and Buy To Open 1 contract of QQQ Jan47Call.
Choosing Strike Prices For Short Call Ladder Spread
The short leg of a Short Call Ladder Spread is usually the At The Money option or a strike price that is nearest the money. This is because the primary profit of a Short Call Ladder Spread, which is the net credit of the position made when the underlying stock remains stagnant or moves downwards, requires as high an extrinsic value as possible and At The Money options contain the highest extrinsic value within the same expiration month.
Middle Strike Price
The closer the middle strike price is to the strike price of the short leg, the more expensive it is and the lower the resultant net credit becomes. This results in a lower profit when the underlying stock remains stagnant or moves downwards as well as a lower maximum loss. The further the middle strike price is to the short leg, the higher the net credit becomes, resulting in a higher profit when the underlying stock remains stagnant or moves downwards and also a higher maximum loss. It also affects the upside breakeven point as it becomes further away as well. This means that the underlying stock would have to rally more in order to start profiting to upside.
As such, in a Short Call Ladder Spread, options traders usually buy the middle strike price two strike prices higher than the short leg for stocks with strike prices at $1 interval or one strike price higher for stocks with strike prices at $5 interval, in order to obtain a more balanced risk profile.
Higher Strike Price
The difference in strike price between the middle strike and the higher strike determines the price range over which maximum loss will occur for a Short Call Ladder Spread. In our QQQ example above, maximum loss will occur when the QQQ closes between $46 (middle strike) and $47 (higher strike) by expiration. Increasing the strike difference between the higher strike and the middle strike results in only a very small increase in net credit but pushes up the higher breakeven point even further and increases the price range over which maximum loss occurs without significant decrease in maximum loss amount.
As such, the higher strike price is usually bought just one strike higher than the middle strike price in a Short Call Ladder Spread.
Trading Level Required For Short Call Ladder Spread
A Level 4 options trading account that allows the execution of credit spreads is needed for the Short Call Ladder Spread. Read more about Options Account Trading Levels.
Profit Potential of Short Call Ladder Spread
Short Call Ladder Spread profits in all 3 directions; When the underlying stock goes downwards (strongly or moderately), remains stagnant or goes upwards strongly. Indeed, the Short Call Ladder Spread has made profitable 4 out of 5 possible outcomes which makes its probability of profit extremely high.
For the stagnant and downwards movement, the Short Call Ladder Spread profits primarily through the net credit gained from writing the higher extrinsic value ATM call options and buying cheaper OTM call options. As long as the price of the underlying stock remains below the strike price of the ATM call options, the net credit is made as profit.
When the price of the underlying stock rally strongly, it will come to a point beyond the strike price of the higher strike call options when the two long call legs will profit more than the single short call leg, resulting in unlimited profit to upside.
Profit Calculation of Short Call Ladder Spread
Maximum Upside Profit = Unlimited
Maximum Downside Profit = Net Credit
Maximum Loss = Lower Long Call Strike - Short Call Strike - Net Credit
Short Call Ladder Spread Calculations
Following up on the above example, assuming QQQQ at $46.50 at expiration.
Wrote the JAN 44 Call for $1.50
Bought the JAN 46 Call for $0.50
Bought the JAN 47 Call for $0.15
Net Credit = $1.50 - $0.50 - $0.15 = $0.85
Maximum Loss = 46 - 44 - 0.85 = $1.15
Max. Upside Profit = Unlimited
Max. Downside Profit = $0.85
Risk / Reward of Short Call Ladder Spread
Maximum Upside Profit : Unlimited
Maximum Downside Profit: Limited to net credit received
Maximum Loss: Limited
Break Even Point of Short Call Ladder Spread
There are 2 break even points to a Short Call Ladder Spread. Loss will occur if the underlying stock closes within the upper and lower breakeven point by expiration.
Upper BEP: Higher Long Strike + Strike difference between short Call and lower long call - Net Credit
Lower BEP: Short Call Strike + Net Credit
Short Call Ladder Spread Breakeven Points Calculation
Upper BEP = $47 + ($46 - $44) - $0.85 = $48.15
Lower BEP = $44 - $0.85 = $43.15
Short Call Ladder Spread Greeks
Delta : Negative
Delta of near month Short Call Ladder Spread is negative at the start. As such, its value will increase as the price of the underlying stock decreases. Delta becomes higher and turns positive with longer expiration month.
Gamma : Positive
Gamma of Short Call Ladder Spread is positive for a start and will will increase overall position delta into the positive allowing the position to profit to upside.
Theta : Negative
Theta of Short Call Ladder Spread is negative for a start and will therefore lose value due to time decay in the short term prior to expiration as the long call legs lose value faster than the short call leg. However, as the short call leg contains more extrinsic value than the long call legs combined, theta will turn positive as expiration approaches, resulting in a profit even if the price of the underlying stock remains stagnant.
Vega : Increases with Length of Expiration
Vega of Short Call Ladder Spread can start slightly negative with near term options and increase to positive as longer expiration options are used. When this is the case, the position would profit on an increase in implied volatility, usually when the underlying stock declines.
Advantages Of Short Call Ladder Spread
:: Able to profit in 4 out of 5 possible moves in the underlying stock
:: Unlimited profit to upside
Disadvantages Of Short Call Ladder Spread
:: Small margin needed as it is a credit spread.