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Bear Call Ladder
Description:
The Bear Call Ladder also known as the Short Call Ladder is an extension to
the Bear Call Spread. By buying another call at a higher strike, the position
assumes uncapped reward potential if the stock soars.
Maximum gain for the short call ladder strategy is limited when the underlying
stock price goes down. In this scenario, maximum profit is limited to the
initial credit received since all the long and short calls will expire worthless.
However, if the underlying stock price rallies explosively, potential profit
is unlimited due to the extra long call.
Example
XYZ is trading at $48.00 on May 17, 2004.
Sell the August 2004 50 strike call for $4.20.
Buy the August 2004 55 strike call for $2.40.
Buy the August 2004 60 strike call for $0.80.
Net Credit = Premium sold - premiums bought
$4.20 - $2.40 - $0.80 = $1.00
Maximum Risk = Middle strike - lower strike
+ net debit (or - net credit)
$55.00 - $50.00 - $1.00 = $4.00
Maximum Reward = Unlimited
Breakeven (Downside) = Lower strike + net debit (or + net credit)
$50.00 + $1.00 = $51.00
Breakeven (Upside) = Higher strike + maximum risk
$60.00 + $4.00 = $64.00
Effect of Time Decay
Time decay is generally harmful when the position is losing money and
helpful when the position is profitable.
Appropriate Time Period to Trade
Depending on the reasons for the trade, it is safest to choose a medium to long
term to expiration, enough time to allow the underlying asset to move and
make the position profitable without time decay destroying the long options.
Stock Selection
Choose from stocks with adequate liquidity, preferably over 500,000 Average
Daily Volume (ADV).
Try to ensure you understand the direction of the trend and identify a clear
area of both support and resistance
Options Selection
Choose options with good liquidity; open interest should be at least 100,
preferably 500.
Lower Strike - Slightly OTM, just above resistance for the stock.
Middle Strike - One or two strikes above the lower strike, i.e., further OTM.
Higher Strike - Above the middle strike, i.e., even further OTM.
Expiration- medium term to expiration (say around six months)
would be safer. Use same expiration date for all legs.
P/L Profile
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