Ladder Option

Last Updated :

21 Aug, 2024

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Table Of Contents

What Is Ladder Option?

A ladder option is a type of options contract that enables the holder to lock in on a partial profit when the asset hits a rug. Investors can make a profit here as long as the underlying asset's market value raises to one or more strike prices before the option expires.

The ladder option strategy gives investors access to a stock's potential growth while also locking in its performance should it ever rise over predetermined levels. It usually takes the form of a capital-guaranteed note with unlimited upside participation. There is also the extra benefit of specific performance when the stock rises above a threshold.

What Is Ladder Option?

A ladder option strategy is a trading strategy holders of an asset employ to maximize its profit-earning capacity.
In this, the holder creates a series of prices apart from the strike price to maximize the profits made. In addition, since the spread is longer, the risk of making a loss is minimal compared to other traditional trading methods.
The more intervals the owner places, the greater their chances of profit. However, the holder should be careful about fulfilling the contract within a specific date.

Ladder Option Strategy Explained

The ladder option meaning implies a strategy investors employ to derive profit from an asset, unlike a traditional option contract that provides the investor the right to either buy (a call option) or sell (a put option) at prevailing prices at the strike price. The strike price of an option is a predetermined amount that remains constant for the duration of the option contract.

In the stock market, an agreement between a buyer and a seller known as a "call option" grants the buyer this- the right, but not the responsibility, to purchase the underlying asset at the strike price on or before the option contract's expiration date. In return for this, the buyer pays the seller a premium.

An agreement in which the buyer can compel the seller (or the person who wrote the option contract) to purchase the security is a "put option." A ladder option is an option that allows the placement of additional price levels above a call ladder option or below a put ladder option. It allows the holders to lock in profits at predetermined levels called rugs, according to the fixed prices.

The pricing of the ladder option is a sequence of higher strike knockout calls with rebates (pay-outs), where the strike of each call is equal to the barrier level of the call before it, and the rebates are equivalent to the locked additional performance. The investor profits in accordance with the prices set between the highest value (call ladder option) and the lowest (put ladder option).

The more intervals a holder places, the more profit-making opportunities they have. The price levels must reach within the contract's expiry date. However, the investor profits even when the market price of the security involved returns to a lower level. Therefore, the profit-making risk involved is much lower than traditional options.

Types

Let us look at the different types of ladder option strategies.

#1 Bull Put Ladder

A Bull put ladder strategy provides unlimited returns if the asset price drops. On the other hand, it gives defined returns in case the price increases and comes with limited financial risk. This is a three-legged, bearish strategy that is better for one to execute if they are sure that the underlying asset’s price would be subject to a significant increase or decrease.

Let us look at a bull put ladder graph to better understand the concept.

#2 Bear Put Ladder

This neutral to bearish option strategy has the potential to provide decent returns. However, the associated risk is high. It involves purchasing 1 at the money (ATM) or out of the money (ITM) put option and offloading a couple of lower strikes out of the money puts at non-identical strike prices.

The following is a bear put ladder option graph.

#3 Bear Call Ladder

This strategy refers to a bear call spread that can help one take advantage of a bearish market outlook. In case the movement materializes on the higher side, the profit potential is unlimited while the risk is limited. This strategy involves purchasing 1 ATM call, offloading 1 ITM call, and purchasing 1 OTM call.

The maximum loss occurs when the underlying asset’s price remains between the higher and the middle strike prices.

The graph below helps one understand this strategy better.

#4 Bull Call Ladder

It is a neutral to bullish options trading strategy that can offer decent financial gains but exposes a trader to higher financial risk. This technique involves purchasing 1 at the money or 1 in the money call options while offloading a couple of different higher strikes at the money or out of the money calls. It is a spread strategy since it includes both long and short positions.

The maximum profits in the case of this strategy cannot exceed a certain level, which one can achieve if the underlying asset’s price is between the sold call options’ strike prices. That said, one must note that the losses will not have any limit in case the asset price goes above the higher strike price.

One can observe the bull call ladder graph below to develop a better understanding of the concept.

Example

Let us look at the ladder option example of a chip manufacturing company called "Gold Chips," which is on the stock market. The call ladder option on the stocks of Gold Chips is $200, and the additional price levels are at $250, $275, and $300, with an expiration date of September 30, 2022.

Suppose they have reached the target of $250 by August 2022, and the holder will receive a pay-out on that level. If the price of $300 reaches by September 15, 2022, the holder will receive a profit at that price level.

Frequently Asked Questions (FAQs)

1. What does the ladder option mean?

A ladder option is a trading strategy where a set of three identical options (all calls or all puts) with different strike prices is traded. Traders who anticipate low volatility use a long ladder, whereas those who anticipate high volatility use a short ladder.

2. What does a call ladder mean?

A call ladder is an options strategy that consists of buying a call at a predetermined strike price and selling the same at a higher strike price. The holder gains profit through the process of placing interval prices. A long call ladder is otherwise known as a bull call ladder.

3. What does a put ladder mean?

Put ladder is an options strategy where the act of purchasing a put at one strike price and selling a put at a lower strike price happens. When two options are bought while one is sold, it is referred to as a "short ladder."

4. What is an option?

Options are contracts that grant the buyer the right, but not the responsibility, to purchase the underlying asset at a certain price on or before a specific date (in the case of a call) or sell it (in the case of a put).