Bear Put Ladder

The Bear Put Ladder is an extension of the basic bear put spread that is a much more complex strategy used when one expects a mediocre to significant downfall in the value of the underlying asset but simultaneously wants to protect against a possibility of upside. It involves a purchase of an in-the-money put, then selling an at-the-money put, and after that, the sale of yet another out-of-the-money put, all for the same term.

Bear Put Ladder


The Structure

Suppose you have a stock trading at $100. You might:

  • Buy an in-the-money put with a strike price of $105 for a premium of $12.
  • Sell an at-the-money put with a strike price of $100 for a premium of $7.
  • Sell an out-of-the-money put with a strike price of $95 for a premium of $3.


Who Should Consider It

This strategy is suitable for the investor who may be bearish on a stock but wants to limit the cost of purchasing puts outright. This strategy is good for the bearish investor, who is worried about the stock’s price rising or rebounding.


Strategy Explained

By selling two puts, an investor reduces the cost of purchasing the put bought. However, the risk level is increased due to the extra sold put which will introduce infinite losses above that highest strike price if the stock price moves quite a bit higher.


Breakeven Process

The breakeven points in a bear put ladder are intricate to calculate as they depend upon the premiums received and paid. There is, in general more than one such point, that is above as well as below the current price of the underlying.


Sweet Spot

The sweet spot for this strategy is just above the lowest strike price of the sold puts at expiration. This way, the investor can maximize the value of the long put position while keeping the short puts worthless.


Max Profit Potential

The maximum profit is limited and occurs if the stock price is at or a bit below the strike price of the lowest sold put at expiration. Thus, the maximum profit is the difference between the strikes of the long and short puts, minus the net premium paid.


Max Loss

The potential loss is unlimited due to the additional sold put if the stock price sharply moves upwards.


Risk

The biggest risk is that the stock price will shoot way up past the highest strike price of the sold puts, causing big losses as the short put positions overwhelm the profits from the long put.


Time Decay

This strategy has nuances in terms of time decay, or theta. The long put loses value with time, but this is partly offset by the decay of the sold puts. Close to expiration, however, the decay of the out-of-the-money put can accelerate if the stock price is far from the put’s strike price.


Implied Volatility

An increase in implied volatility generally helps the long put more than it hurts the short puts, hence beneficial to the overall position. A decrease in volatility can harm the position by making it cheaper to close the shorts and decreasing the value of the long put.


Conclusion

A bear put ladder is a versatile strategy for the bearish investor who wishes to lower up-front costs while preparing for multiple outcomes in price movement. This strategy requires careful monitoring and potentially adjusting as market conditions change.