Execute A Long Call Ladder or Bull Call Ladder

Introduction To Long Call Ladder(Bull Call Ladder) Option Strategy

 

The long call ladder is also known as the bull call ladder. It is an option trading strategy that is constructed with call options, with the same expiration date, derived from the same underlying security, but with different exercise(strike) prices. For how the long call ladder is set up, read Step 11. The greater the price increase of the underlying security, the greater the loss of the trader who executes this the long call ladder.

Long call ladder – a net debit trade

The long call ladder is a net debit trade, which means that deductions are made from the account of the trader when the trade is established. The reason that it is a net debit trade is because the long call costs more than the combined premium collected from shorting the other calls.

Long call ladder vs bull call spread

Since 2 calls are shorted for every long call, the cost of entering a long call ladder trade is decreased because it increases the collection of the shorted options premium. As a result, it is cheaper to enter into a long call ladder than a bull call spread. A bull call spread is executed with a ratio of 1 long call to 1 short call.

The disadvantage of having more shorted calls than long calls in a long call ladder trade is that it actually leaves the trader open to an unlimited loss as the price of the underlying security increases.

Steps

Step 1 :Perform economic, fundamental and technical analysis
Step 2 :Outlook – Anticipate Little Volatility
Step 3 :Study the option chain
Step 4 : Perform Breakeven Analysis
Step 5: Understand Your Profit Zones
Step 6 : Unlimited potential loss
Step 7 : Calculate Loss
Step 8 : Maximum profit
Step 9 : Calculate Profit
Step 10 : Calculate Risk & Reward Ratio
Step 11 : Set Up Trade : Setting up a long call ladder or bull call ladder
Step 12 : Exit Trade
Step 13 : Record Trade In Diary

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Step 1 : Perform economic, fundamental and technical analysis

Perform economic, fundamental and technical analysis to gain a conviction that the markets and the  underlying security will trade with little fluctuation and volatility. Some chart patterns traders can look out for is:

Read : Basic Economic Analysis , Basic fundamental Analysis and Introduction to technical analysis

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Step 2 :Outlook – Anticipate Little Volatility

The trader who executes a long call ladder is anticipating little to no volatility of the price of the underlying security. This will increase the probability that the maximum profit is earned.

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Step 3 :Study the option chain

Next, it is time to select option contracts with different strike prices that will form the long call ladder. Structure the long call ladder in a way  that minimises the net debit.

Read :  Learn to read and understand options chain

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Step 4 : Perform Breakeven Analysis

There are 2 breakeven price points. There is a downside breakeven price point and an upside breakeven price point. If the price of the underlying security trades above or below the upside and downside breakeven price points respectively, the trader will experience a loss.

The downside breakeven price point can be calculated as:

S1 Lowest exercise(strike) price + net debit

The upside breakeven price point is:

S3 + S2 – S1 + net debit

S3 and S2 are the exercise(strike) prices of the written calls. S1 is the strike price of the bought call which is the call options with the lowest strike price. So, to find the upside breakeven point, add the strike prices of the shorted calls, subtract the strike price of the long call and finally, add the net debit paid to establish the trade. The net debit is the total premiums paid and results in a deduction from the trader’s brokerage account.

S1 is the lowest strike price and S3 is the highest strike price.

In this way, S1<S2<S3

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Step 5: Understand Your Profit Zones

Execute A Long call ladder or bull call ladder

Execute A Long call ladder or bull call ladder

After breakeven analysis is performed, the options trader will understand his profit zone. The trade is profitable when it trades between the breakeven points.

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Step 6 : Unlimited potential loss

The loss becomes greater as the price of the underlying security moves above the upside breakeven point. As the price of the underlying security moves below the downside breakeven point, the losses tend towards a  limited loss scenario. Refer to the payoff diagram above.

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Step 7 : Calculate Loss

If the price of the underlying security is greater than the upside breakeven price point, the loss can be calculated as:

upside breakeven price point – price of underlying security – commissions paid to broker

When the price of the underlying security breaks towards the downside, the loss is limited to the net debit created when the trade is executed.

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Step 8 : Maximum profit

Maximum profit is attained when the price of the underlying security is trading between the exercise(strike) prices of the written calls. When that happens, a maximum and limited profit is earned. That is the reason why the long call ladder strategy is known as a strategy with a limited profit potential. This occurs because of the way the long call ladder is constructed where every long call has 2 short calls accompanying it.

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Step 9 : Calculate Profit

The maximum profit can be calculated as:

Middle exercise(strike) price – Lowest exercise(strike) price + net debit – commissions paid to broker

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Step 10 : Calculate Risk & Reward Ratio

It is important to calculate the risk and reward ratio thereafter. This is very important as traders sometimes make trades in which the risk and reward ratio is not attractive. Since traders are putting their capital on the line, it is essential to have an attractive risk and reward ratio.

Read more : Understanding Risk/Reward Ratio For Option Traders

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Step 11 : Set Up Trade : Setting up a long call ladder or bull call ladder

The long call ladder or the bull call ladder as its name suggest consists of call options. The way to create a long call ladder or bull call ladder is to:

  • Long 1 in the money call (lowest strike price)
  • Write 1 at the money call (Middle strike price)
  • Write 1 out of the money call ( highest strike price)

The ratio of in the money calls to at the money calls to out of the money calls is 1 : 1 : 1. Hence, a trader who longs 10 in the money call, short 10 at the money calls and short 10 out of the money calls is also executing a long call ladder as it adheres to the ratio above.

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Step 12 : Exit Trade

Exit the trade especially if the price of the underlying security is trading at a price at which there is an increased possibility of assignment. Consider exiting above the upside breakeven point and when the trade has a reasonable amount of profit.

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Step 13 : Record Trade In Diary

Record the trade in a diary. Analyse performance against other trades and learn from any mistakes made.

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Example Of a Long Call Ladder

WWW Corp currently trades at a price of $55. A trader decides to execute a long call ladder as he forsees that the price of WWW will trade between $55 and $60. He executes a long call ladder(bull call ladder) by:

  • Long 1 Dec 50 call @ $6
  • Short 1 Dec 55 call @ $2
  • Short 1 Dec 60 call @ $1

As a result, there is a net debit. The net debit can be calculated as:

($6 – $2 – $1) x 100 = $300

Hence, $300 is the net debit which is also sometimes considered the net premiums paid to establish the trade.

If the price of WWW trades between $55 and $60, the trader will earn a maximum profit. The maximum profit is:

($55 – $50 – $3) x 100 = $200

$200 is hence the maximum profit.

Let us examine a price point at which the maximum profit can be experience.

If the price of WWW trades at $58 on expiration of the options:

Beginning value Ending value Profit(+) or Loss(-)
Long 1 Dec 50 call $6 $8 +$2
Short 1 Dec 55 call $2 $3 -$1
Short 1 Dec 60 call $1 $0 +$1
Overall profit $3

So the above table is the respective profit and loss earned from each position if it was closed on expiration. For options that expire worthless, we assign a $0 value. This is done to facilitate and ease of calculating the overall profit or loss.

In this case, there is an overall profit per share of $3.

So the maximum and total profit is:

$3 x 100 = $300

The upside breakeven point is:

$55 + $60 – $50 – $3 = $62

When the price of the underlying security trades above the upside breakeven point and moves significantly upwards, the trader can incur an unlimited loss. Let us examine the extreme example if the price of WWW trades at $200.

When the price of WWW trades at $100 in expiration:

Beginning value Ending value Profit(+) or Loss(-)
Long 1 Dec 50 call $6 $50 +$44
Short 1 Dec 55 call $2 $45 -$43
Short 1 Dec 60 call $1 $40 -$39
Overall loss -$38

The total loss is :

$38 x 100 = $3800

As you can see, the loss where there is a significant move to the upside is a huge one. The loss potential is unlimited because the price of the underlying security can theoretically go up infinitely.

Short strangle, variable ratio write and long call ladder – Profiting from low volatility

The short strangle, variable ratio write and long call ladder are similar strategies in a sense that they capitalise on low volatility conditions of the underlying security. In range bound trading conditions, these strategies can earn a maximum profit.

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