To make a profit in the market, traders use several call options. To make a profit on the option premium, a bear call spread sale is when a call option sells at a lower price that its strike price. The bearish outlook of the trader regarding stocks makes it a profit. The option premium earned by the sale is always greater than the premium for buying the call.
Trading refers to an option contract (call or put), that allows you to make a profit from one or more strike price until the options expire. To allow for more flexibility in a payoff, it changes to adapt to the gap between the old strike prices and the new strike prices. Trigger strikes act as a ceiling. This allows you to know when an asset price has reached trigger. It also locks in profit, reducing risk.
Although it may sound confusing, a bear call ladder strategy can be used when the market is bullish. This is also known as the "short call ladder" because it involves selling another call option 'in-the-money' to buy new options. To build a ladder one must make sure that both call option have the exact same expiry dates and the same underlying asset. The ratio must also be maintained. It is often set up by traders for 'net credit.
To make a profit from the short call ladder, you need patience and practice to understand market movements. It is best to engage in it only when you feel certain that the market will move higher. Let's talk in detail about the bear call ladder strategy.
Your short ladder strategy should be based on moderately bearish investors' outlooks about the stock index. The underlying asset price will fall which could trigger the selling off of options.
The bear call ladder is a three-legged option that's usually used to realize 'net credit.
It has three legs:
1. One ITM (In the Money) call option can be sold
2. Call option to buy 1 ATM (At the Money)
3. Option to buy 1 OTM (Out Of The Money) call
This classic bear ladder setup shows that one ITM call option is sold and that one ATM call option, one OTM option are purchased. It's a 1:1 combination. Other common combinations include 2:2:2 or 3:3:3.
These are some tips to keep in mind when you're trying to make a bear call ladder.
- Choose options that offer greater liquidity
- Open interest is between 100 and 500. 100 is the base limit and 500 is better.
- Lower strike depicts ITM
- The OTM or medium strike is one to two strikes above OTM
- A higher strike means that you are OTM even more than a medium strike
You must also ensure that you are able to access the internet.
1. All call options that were traded during the bear call ladder have the same expiry
2. You belong to the same underlying
3. Ratio between call options is maintained
Let's look at a bear call ladder trade setup with an example.
Let's say that the Nifty spot is at 7790 and you expect it will move to 8100 at the expiry. This is undoubtedly a bullish trend. Let's now learn how to start a bear call ladder.
Step 1: Sell 1 ITM option at 7600 CE, and realize a premium option for Rs.247
Step 2: Buy 1 ATM Call Option at a Premium of Rs.117
Step 3: Buy 1 OTM Call Option at a Premium of Rs.70
The net realised profit is 247 - 117-90 = 60
This is a great example of how a bear-call ladder trade works in a market. In real life, however, you'll face more complicated situations that will determine whether your deal will turn out in your favor or not. This strategy generalization will help navigate the complex world of call ladders.
Bear call ladder offers higher profit opportunities and is an improvised call ratio spread.
In a classic scenario, 1 ITM CE is sold and 1 ATM CE purchased.
- Net credit can be calculated by subtracting the premium paid to ATM & OTM CE and the premium received at ITM CE. This is the amount that you pay when the market falls.
- The maximum loss is calculated by subtracting net credit value from spread. This is the difference between ITM Option and ITM.
ATM/OTM Strike: Maximum loss
- The lower breakeven is the sum of Net Credit and Lower Strike.
- The formula to calculate the upper breakeven is = Sum a Long strike - (Short struck - net premium).
When the market is showing strong upward tendencies, it's a good rule of thumb to use a bear call ladder strategy.
This table illustrates how profit and loss can be determined in different market situations.
In trading terms, the term 'Greeks" is used to indicate different levels of risk involved in an option position. Options traders use Greek alphabets to represent these values and hedge against price movements. In terms of volatility, the impact of Greeks on bear call ladder is similar to that in Call Ratio Back spread.
- The blue line indicates an increase in volatility within 30 days of expiry
- Green Line is volatility within 15 days of expiry
- The red line denotes volatility when the expiry date is immediately
Bear call ladder has the greatest advantage: you can profit on almost all occasions, particularly when the market is moving upwards.