Long Call Ladder
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The long call ladder, or bull call ladder, is a limited profit, unlimited risk strategy in options trading that is employed when the options trader thinks that the underlying security will experience little volatility in the near term. To setup the long call ladder, the options trader purchases an in-the-money call, sells an at-the-money call and sells another higher strike out-of-the-money call of the same underlying security and expiration date.
|Long Call Ladder Construction|
|Buy 1 ITM Call|
Sell 1 ATM Call
Sell 1 OTM Call
The long call ladder can also be thought of an extension to the bull call spread by selling another higher striking call. The purpose of shorting another call is to further finance the cost of establishing the spread position at the expense of being exposed to unlimited risk in the event that the underlying stock price rally explosively.
Limited Profit Potential
Maximum gain for the long call ladder strategy is limited and occurs when the underlying stock price on expiration date is trading between the strike prices of the call options sold. At this price, while both the long call and the lower strike short call expire in the money, the long call is worth more than the short call.
The formula for calculating maximum profit is given below:
- Max Profit = Strike Price of Lower Strike Short Call - Strike Price of Long Call - Net Premium Paid - Commissions Paid
- Max Profit Achieved When Price of Underlying is in between the Strike Prices of the 2 Short Calls
|Long Call Ladder Payoff Diagram|
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Limited Downside Risk, Unlimited Risk to the Upside
Losses is limited to the initial debit taken if the stock price drops below the lower breakeven point but large unlimited losses can be suffered should the stock price makes a dramatic move to the upside beyond the upper breakeven point.
The formula for calculating loss is given below:
- Maximum Loss = Unlimited
- Loss Occurs When Price of Underlying > Total Strike Prices of Short Calls - Strike Price of Long Call - Net Premium Paid
- Loss = Price of Underlying - Upper Breakeven Price + Commissions Paid
There are 2 break-even points for the long call ladder position. The breakeven points can be calculated using the following formulae.
- Upper Breakeven Point = Total Strike Prices of Short Calls - Strike Price of Long Call - Net Premium Paid
- Lower Breakeven Point = Strike Price of Long Call + Net Premium Paid
Suppose XYZ stock is trading at $35 in June. An options trader executes a long call ladder strategy by buying a JUL 30 call for $600, selling a JUL 35 call for $200 and a JUL 40 call for $100. The net debit required for entering this trade is $300.
Let's say XYZ stock remains at $35 on expiration date. At this price, only the long JUL 30 call will expire in the money with an intrinsic value of $500. Taking into account the initial debit of $300, selling this call to close the position will give the trader a $200 profit - which is also his maximum possible profit.
In the event that XYZ stock rallies and is trading at $50 on expiration in July, all the call options will expire in the money. The short JUL 35 call will expire with $1500 in intrinsic value while the short JUL 40 call will expire with $1000 in intrinsic value. Selling the long JUL 30 call will only give the options trader $2000 so he still have to top up another $500 to close the position. Together with the initial debit of $300, his total loss comes to $800. The loss could have been worse if the stock had rallied beyond $50.
However, if the stock price had dropped to $30 instead, all the calls will expire worthless and his loss will be the initial $300 debit taken to enter the trade.
For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.
However, for active traders, commissions can eat up a sizable portion of their profits in the long run. If you trade options actively, it is wise to look for a low commissions broker. Traders who trade large number of contracts in each trade should check out OptionsHouse.com as they offer a low fee of only $0.15 per contract (+$4.95 per trade).
The following strategies are similar to the long call ladder in that they are also low volatility strategies that have limited profit potential and unlimited risk.
|View More Similar Strategies|
Short Call Ladder
The converse strategy to the long call ladder is the short call ladder. Short call ladders are employed when large movement is expected of the underlying stock price.
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