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Derivative trading is one of the most sought-after asset classes used by professional investors to ensure they make profits irrespective of the market trend. Among the two methods of Derivatives Trading: Futures and Options, investors who have a higher risk appetite and extensive knowledge about the market choose Options Trading.
As Options Trading involves buying and selling Call and Put options simultaneously, it allows investors to create a hedge against the rise of the falling market. This blog details a three-legged Options strategy known as Bear Call Ladder. However, to understand the strategy, the first step is to understand some common jargon related to Options Trading.
Options are contracts that grant the holder the right but do not bind them, to either buy or sell a sum of some underlying asset at or before the contract expiration at a fixed price. Options can be acquired with brokers such as IIFL through online trading accounts as with any other asset group. You can buy or sell stocks, ETFs, etc., at a fixed price over time through online trading options.
This online trading method also gives buyers the flexibility not to purchase the security at the defined price or date. Although it’s a little more complex than stock trading, options yield comparatively greater returns if the security price goes up. This is because you do not have to pay the full premium for the insurance of an options contract. Similarly, selling options will reduce your losses if the security price goes down, also known as hedging.
This is a contract wherein you win the right, but not the obligation, to buy a certain underlying asset at a decided-upon price and date between the contracting parties. Since there is no obligation to purchase, you do not need to execute it unless it is profitable to you.
A Put option works exactly opposite to the call option. While the call option equips you with the right to buy, the put option empowers you with the right to sell the stock on the date agreed upon by the contracting parties.
Options trading may seem straightforward to execute. However, there are numerous complicated strategies such as Bear Call Spread, Bull Put Spread, etc., that investors use depending on where the market is going. One such strategy is Bear Call Ladder. A bear call ladder is an extension to the previously defined Bear Call Spread.
A bear call spread is a two-legged options trading technique that involves selling a call option with a lower strike price to collect an upfront premium and simultaneously buying a new call option with a higher strike price. The underlying asset and the expiration date in both contracts are the same. The idea is to profit from the premium amount. As the premium for a short call (an options contract with a lower strike price is higher than the premium amount of a call option contract with a higher strike price, the investors realize profits in between.
Also known as Short Call Ladder, a Bear Call Ladder is a three-legged options strategy that is usually set up for a ‘net credit’ of premium. It includes selling one in-the-money call option, buying one at-the-money call option, and buying another out-of-the-money call option simultaneously. The idea behind Bear Call Ladder is to finance the cost of purchasing call options by selling an extra ‘in-the-money’ call option.
Unlike Bear spreads, the Bear Call Ladder is not a strategy executed in a bearish market. The Bear Call Ladder strategy is used when the market is bullish as an improvisation over yet another spread called the Call Ratio Back Spread.
Here is a detailed example for understanding how a Bear Call Ladder is executed in the market:
Suppose the Nifty Spot is at Rs 8,500, and you expect the market to be bullish and the Nifty spot to reach Rs 9,500 by the time of expiry. In this case, you can implement a Bear Call Ladder mentioned below:
The underlying asset, the ratio, and the expiry are the same for the three call options.
Now, the trade setup with look something like this:
Net Credit: Rs 50 (250-50-50)
Scenario 1: Market closes at Rs 8,400 (below the lower strike price)
Option 1: Expires worthless
Option 2: Expires worthless
Option 3: Expires worthless
Net profit: Rs 50 (250-50-50)
Scenario 2: Market closes at Rs 8,420 (lower strike + net premium received)
Option 1: Will have an intrinsic value of Rs (8,420-8,400) = Rs 20
Option 2: Expires worthless
Option 3: Expires worthless
Net profit: Rs (250-20)-150-50 = Rs 30
Scenario 3: Market closes at Rs 8,480
Option 1: Will have an intrinsic value of Rs (8,480-8,400) = Rs 80
Option 2: Expires worthless
Option 3: Expires worthless
Net Loss: (250-80)-150-50 = Rs 30
Here are the advantages and disadvantages of Bear Call Ladder:
As an extension of Bear Call Spread, the Bear Call Ladder is a great strategy to use and even manage your Bear Call Spread. If you believe that the market is showing an uptrend, you can enter into a Bear Call Ladder strategy to ensure profitability on almost all occasions. However, as the strategy comes with its risks, you can contact IIFL to get valuable insight and expert guidance on successfully planning and executing a Bear Call Ladder strategy. You also may want to check out the pcr ratio to be updated on the market sentiment only at IIFL.
To execute a Bear Call Ladder, you should implement the following three transactions simultaneously:
However, you should ensure that the underlying asset, ratio, and expiry date for all three call options are the same.
Yes, a Bear Call Ladder Strategy can be highly profitable if the market is bullish. The profit potential in a Bear Call Ladder strategy is unlimited once the underlying asset’s price crosses the upper breakeven point.
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