A-Z of Bear Call Ladder

5 mins read
by Angel One

Traders use several call options to trade in the market to make a profit from it. A bear call spread sell happens when a call option is sold at a lower price than its strike price to earn a profit from the option premium received for the call option sold. It makes a profit from the bearish outlook of the trader about stocks. The option premium earned from the sell is always higher than the premium paid for purchasing the call.

What are ladders in trading?

In trading, ladder refers to an options contract (call or put) that allows earning profit from one or more strike prices till the options expire. It changes to adjust with the gap between the old and new strike prices to allow more flexibility in a payoff. The trigger strikes work as a ceiling. It lets you know when an asset price reaches trigger and thus, reduces risk by locking in a profit.

What is a bear call ladder?

It may sound confusing, but a bear call ladder strategy is executed when the market is bullish. It is also called the ‘short call ladder’ because buying new call options is financed by selling another ‘in the money’ call option. But to execute a ladder, one must ensure that both call options have the same expiry dates, same underlying asset, and must also maintain the ratio.  Traders set it up often for ‘net credit’.

Bear call ladder strategy

Profiting from short call ladder needs practice and patience to understand market movements. You must engage in it when you are sure that the market will move to a higher position. To understand it better, let’s discuss in detail about bear call ladder strategy.

You must base your short ladder strategy when investors outlook is moderately bearish about the stock index; underlying asset price is expected to fall, which trigger the selling of options.

Bear call ladder is a three-legged option, usually set up to realise ‘net credit’.

The  three legs of it include:

1. Selling off one ITM (In The Money) call option

2. Buying of 1 ATM (At The Money) call option

3. Buying of 1 OTM (Out of The Money) call option

It is a classic bear ladder set-up that depicts that for one ITM call option sold, one ATM call option and one OTM call option are brought –   a 1:1:1 combination. Other combinations practised commonly are 2:2:2 and 3:3:3.

While executing a bear call ladder, keep the following tips in mind.

– Select options which offer higher liquidity

– Open interest ranges between 100 and 500, where 100 is considered the base limit, and 500 is considered better

– Lower strike depicts ITM

– Medium strike or the OTM is one or two strike above OTM

– A higher strike is even further OTM, above medium strike

Also, you must make sure

1. All the call options traded during bear call ladder belong to the same expiry

2. Belong to the same underlying

3. Ratio between the call options is maintained

Let’s discuss a bear call ladder trade set-up with an example.

Say, Nifty spot is 7790, and you expect it to move to 8100 by the end of the expiry period. It is undoubtedly a bullish trend. Let’s now see how to initiate a bear call ladder.

Step 1: Selling 1 ITM call option at 7600 CE and realise a premium option of Rs.247

Step 2: Buying 1 ATM call option at a paid premium amount of Rs.117

Step 3: Buying 1 OTM call option at a paid premium amount of Rs.70

Net realised profit from the deal is 247 – 117-70 = 60

This one is an ideal scenario to explain to you how a bear call ladder trade happens in a market. But in real life, there will be more complex situations which will decide whether you will make a profit from your deal or loss. However, the following strategy generalisation will help you navigate through the complex world of call ladders.

A generalisation of bear call strategy

– Bear call ladder is an improvised form of call ratio spread, and it offers greater profit opportunity.

– In a classic situation, it is executed by selling 1 ITM CE, buying 1 ATM CE, and 1 OTM CE

– Net credit is determined by the formula of subtracting premium paid to ATM & OTM CE from the premium received from ITM CE. It is the payoff amount when the market goes down.

– Max loss is calculated by subtracting net credit value from the spread, which is the difference between ITM and ITM Option.

– Maximum loss occurs during ATM and OTM  Strike

– Lower breakeven is the combined value of Lower Strike and Net Credit

– The formula for calculating upper breakeven is = Sum of a Long strike – (Short strike –  net premium)

– The thumb rule to execute a bear call ladder strategy is when market shows strong upward tendencies.

The table shows how profit and loss are determined in different market scenarios.

Effects of Greeks 

‘Greeks’ in trading terms is used to describe different levels of risks involved in taking an option position. These values are typically represented by Greek alphabets, used by options traders to hedge risks as price moves. The impact of Greeks in bear call ladder is the same as in Call Ratio Back spread, especially in terms of volatility. See the following diagram for understanding.

– Blue line represents an increase in volatility in 30 days expiry

– Green Line represents volatility within 15 days expiry

– Red line depicts volatility when expiry date is immediate

The most significant advantage of using bear call ladder is that you can make a profit on most occasions, especially when the market shows an upward movement.