Long Put Ladder – ( Bear Put Ladder)
The Long Put Ladder, sometimes referred to as the Bear Put Ladder, is a strategy for options trading when a trader has a bearish view of the underlying asset but still wants to limit his upfront cost and maximize potential return in case the value of the underlying moves sharply below. The approach consists of the purchase of put options at a higher strike price along with the selling of more put options at two lower strike prices.
The Long Put Ladder Setup
Assuming you are watching a stock trading at $100 and expect it to decline but potentially drop precipitously. You could establish the Long Put Ladder by:
- Purchasing one put option with a strike price of $100 for a premium of $7.
- Selling one put option with a strike price of $90 for a premium of $4.
- Sell another put option for a strike price of $80 for a premium of $2.
This position creates a net debit (cost) at the outset but is structured to benefit from both modest and large stock price declines.
Who Should Consider It
This strategy is suitable for investors who expect a moderate decline in the underlying asset but want to hedge against a potential plunge. It is ideal for those looking to limit the upfront cost while maintaining exposure to further downward movement.
Strategy Explained
In a Long Put Ladder, the cost of purchasing the higher strike put is compensated by the premiums collected from selling the two lower strike puts. This not only reduces the total investment but also extends profit potential if the stock plummets beyond the lowest strike price.
Breakeven Process
The breakeven points for a Long Put Ladder are somewhat complicated by the multiple positions. The upper breakeven is usually calculated as the highest strike price minus the net premium paid. The lower breakeven is less straightforward and depends on the extent of the stock’s decline and the arrangement of the strikes.
Sweet Spot
The best-case scenario for this strategy is when the stock price drops to slightly below the lowest strike price at expiration. With this, the buyer can earn the most intrinsic value on the long put without causing or minimizing losses on the short puts.
Max Profit Potential
The maximum profit is capped in case the stock price falls within the middle and lowest strike prices. Beyond the lowest strike, profits can be made again; theoretically unlimited, if the stock goes to zero, as the intrinsic value of the deep in-the-money long put outweighs the losses from the short puts.
Max Loss
This occurs at expiration, the maximum loss of the premium if the stock price is above or equal to the highest strike, resulting in the loss being equivalent to the net premium paid. There is significant risk when the stock price declines substantially below the lowest strike, and without additional protection, losses on the short put increase considerably.
Risk
The Long Put Ladder has a pretty high risk, especially during an extreme fall of the stock price greatly below the lowest strike price, as the short puts become much more valuable, costing the trader in big losses.
Time Decay
Time decay, or theta, tends to work against this strategy when the underlying stock price is around the strikes of the sold puts, because the value of these options will grow as they become nearer to being in-the-money.
Implied Volatility
Changes in implied volatility may have a mixed effect on this strategy. The general increase in volatility will increase the value of the long put more than the short puts, thus favorably improving the position. Conversely, a decrease in volatility might lower the value of the long put more adversely than the impact on the short puts.
Conclusion
The Long Put Ladder is a nuanced strategy that requires careful planning and risk management. It is best used by experienced traders who can closely monitor market movements and adjust their positions as necessary to protect against excessive losses while still capitalizing on bearish market movements.