Bull Put Ladder

 

Description         

            

The Bull Put Ladder is an extension to the Bull Put Spread. By buying another put at a lower strike, the position assumes uncapped reward potential if the stock plummets.

 

The problem is that now it is not totally clear if we have a bullish or bearish strategy, but because we are net long puts and we have uncapped profit potential if the stock falls, do we have to call this a bearish strategy? The answer lies in the reason for the trade and the position of the stock relative to the strikes.

 

Because we are net long options (and particularly out-of-the-money options), we are better off trading this as a longer term strategy in order to counter the effects of time decay.

 

So, in summary, if the stock falls below the lower (buy) strike, we make potentially uncapped profit until the stock reaches zero; if the stock rises to anywhere between the middle and upper (short) strikes, we make our maximum loss. The extra leg also ensures that we may have two break even points.

 

Market Opinion

 

Bearish.

         

P/L

 

 

 

 

 

 

 

  

When To Use

 

Use this strategy for capital gain in a bearish environment.

 

Example

 

XXXX is trading at $52 on May 10, 2011.

Buy August 2011 40 strike put for $1.20.

Sell August 2011 45 strike put for $2.40.

Sell August 2011 50 strike put for $4.60.

 

Benefit

 

This strategy has unlimited profit potential with capped risk.

 

Risk vs. Reward

 

The risk is limited to the difference between the lower and middle strikes minus interim risk. The reward is uncapped.

 

Net Upside

 

Lower strike minus maximum risk.

 

Net Downside

 

The difference between the middle and higher strikes plus net debit.

 

Break Even Point

 

Break even point up: Higher strike plus net debit or minus net credit.

 

Break even point down: Lower strike minus maximum risk.

 

Effect Of Volatility

 

High volatility.

 

Effect Of Time Decay

 

Negative when you are losing money, especially near the middle strike.

 

Alternatives Before Expiration

 

This position is best closed out at least one month before expiration to either contain losses or capture profit.

 

Alternatives After Expiration

 

Close out the position by buying back the puts sold and selling the puts bought.