How to Trade a Short Call Ladder

If you love trading Ladders then you should learn how to trade a Short Call Ladder Strategy (or Short Put Ladder that I will discuss in my next post). The reason is that they have limited risk, unlimited profits potential (only on paper) – in reality Short Call Ladder is not a good strategy. We will shortly know why.

On paper they are better than Long Ladders because of the limited risk and unlimited profits – but unfortunately though limited, the risk is just too much on the Short Call Ladder and getting unlimited profits is difficult. Therefore you should know this strategy to actually avoid trading this. Still I highly recommend you read this article to enhance your knowledge.

I don’t have a problem with too much limited risk if the risk can be managed. However, with Short Call Ladder the only option is to take a stop loss if the risk increases beyond comfort level. Interestingly even that cannot be done as the stock has to travel from the worst zone to the best zone.

If you don’t know whether the stock will be in the best zone a few days from now or on expiry day – how can you even take a stop loss when the stock is in the worst zone? If you did not understand what I just said, it’s fine, I will discuss this later as well.

How to Trade a Short Call Ladder?

The view: If you think Nifty/Stock will move up during the next few days and volatility too will increase, Short Call Ladder is one of the (worst) strategies to play.

Note: There are many better strategies to play if your view is bullish. The risk-reward is good in this strategy, but only on paper. You will shortly know why this strategy is not a good bullish play.

The Short Call Ladder Trade:

Sell 1 Lot In The Money (ITM) Call Option
Buy 1 Lot At The Money (ATM) Call Option
Buy 1 Lot Out of The Money (OTM) Call Option

Risk: Limited
Reward: Unlimited

First have a look at the graph below and then read to understand the trade:

Please Note: In the above graph the trader has received a credit trading the Short Call Ladder. However when I looked for real prices that were given to me as a retail trader, I had to give a credit. In rare occasions you may also get a credit. If you get a credit this trade may be tried, because if the stock falls you will end up keeping the credit. If the stock rises too much, you end up making money. Still this is not a good trade as the credit you may receive will be small and not justify the risk you take.

I will now trade a real (paper) trade as an example to help you understand why this trade is not as good as it sounds. I highly recommend looking for some other trade like a debit spread trade if your view is bullish. You can even try long call ladder. Though in the long call ladder the risk is unlimited its a better trade in my view because the stock has to travel from a profitable zone to a loss making zone. You can always stop out your profits before the stock moves into the negative zone. 🙂

Lets do the trade:

Date: 22-December-2014
Time: 1.35 pm (Markets are Open)
Nifty Spot: 8247
India VIX (Volatility): 14.61

Note: Volatility may drop or rise, we don’t know. But still lets trade this as the results will be shown for the expiry day, so for this paper trade volatility does not matter.

(For people who don’t know, on the expiry day there is zero volatility and time value in an option. What is left is the intrinsic value. Therefore we are right now not much bothered about the Volatility.) However increase in Volatility will help as the trader here has double the number of buy options than sell options. Volatility helps the option buyer. (Increase in Volatility means option values will also increase.)

Lets get the Jan 2015 option prices online. Dec 2014 options will expire 3 days from today so I have taken January values:

Sell 1 Lot In The Money (ITM) Call: 29-Jan-15 8,200 CE: 209.75
Buy 1 Lot At The Money (ATM) Call: 29-Jan-15 8,300 CE: 148.00
Buy 1 Lot Out of The Money (OTM) Call: 29-Jan-15 8,400 CE: 98.90

Note: Since Nifty is at 8247 we could have traded this with 8100, 8200, & 8300 – with 8200 treated as ATM. In our current trade we are treating 8300 as ATM.

Had I done the trade with 8100-8300 my risk would have increased as I will buy the 8200 and 8300 option – though I will receive more from selling the 8100 option – my total outgoing will be bigger than the current trade.

I am not comfortable with putting too much money on risk, but your view may differ. Depending on your comfort level you can always treat slightly In The Money options (ITM) as At The Money (ATM).

You can say in that case I should have gone further up to save money. Well you have a valid question, but there is a problem. My risk will increase if I go up. Why will the risk increase? Because Nifty will have to move up significantly to generate profits. Later we will see why a significant move is required. A small movement will still be a loss for a short call ladder done on strikes deep out of the money.

The decision to trade which strike price is a VERY important decision for an option trader, especially if the trade involves trading At The Money (ATM) options and when the stock or Index is NOT exactly At The Money (ATM).

Some may say, I could have chosen the 8250, 8350 and 8450 options – but people who have taken my course know that I hate trading these options as they are not highly liquid. (Once I was not even able to take a stop loss in the 50s option because no one was trading. Result? By the time it was liquid I lost close to 17,000 🙁 . Lesson learned – stop trading options that are not liquid.)

Liquid options also helps to get a better fill, and make more money in the same effort because the ask and bid are very close. Moreover the results will be almost same. So why take the extra risk?

Now lets do the Short Call Ladder Trade. (To keep calculations simple I always do paper trading in 100 shares. Risk reward remains same for 1 lot or 4 lots on margin blocked):

Sell 8,200 CE: 209.75 * 100 = +20975
Buy 8,300 CE: 148.00 * 100 = -14800
Buy 8,400 CE: 98.90 * 100 = -9890

Total Debit: 20975-14800-9890 = 20975-14800-9890 = -3715

This is not our max risk. We will see soon max risk is too much in this trade.

Lets see the results on the expiry day:

Nifty at 8,200 on 29-Jan-15:

All options expire worthless. The trader loses Rs. 3715.00. Nifty expiring anywhere below 8200 the results will be same.

Nifty at 8,300 on 29-Jan-15:

Sell 8,200 CE will be 100: 20975 – (100 * 100) = +10975
Buy 8,300 CE will expire worthless: -14800
Buy 8,400 CE will expire worthless: -9890

Total Loss: 10975-14800-9890 = -13,715.00

This is our max risk. For selling 100 shares of Nifty almost 55,000 will be blocked. Since buying is for protection, most brokers will not block capital required for 8300, but for 8400 buy almost 10,000 will be blocked. Total margin required: 55000 + 10000 = 65,000.

Lets calculate the % max risk: (-13715/65000)*100 = -21.10%

Is this really limited risk? Are you comfortable losing 21% of your capital if wrong in just one trade? At least I am not. I don’t care what profits a trade can make – but if the risk is hard to manage and 21% of my money is at risk – I will not trade such a trade. Period.

Nifty at 8,400 on 29-Jan-15:

Sell 8,200 CE will be 200: 20975 – (200 * 100) = +975
Buy 8,300 CE will be 100: -14800 + (100 * 100) = -4800
Buy 8,400 CE will expire worthless: -9890

Total Loss: 975-4800-9890 = -13,715.00

Nifty at 8,500 on 29-Jan-15:

Sell 8,200 CE will be 300: 20975 – (300 * 100) = -9025
Buy 8,300 CE will be 200: -14800 + (200 * 100) = 5200
Buy 8,400 CE will be 100: -9890+ (100 * 100) = 110

Total Loss: -9025+5200+110 = -3715.00

Note: On expiry if Nifty is anywhere below 8500, the trader still loses. Remember that this trade was initiated when Nifty was at 8247. Even after traveling more than 3% if a bullish trade loses money then it cannot be called a good strategy. Had you done a debit spread you would have made great money by now.

Nifty at 8,600 on 29-Jan-15:

Sell 8,200 CE will be 400: 20975 – (400 * 100) = -19025
Buy 8,300 CE will be 300: -14800 + (300 * 100) = 15200
Buy 8,400 CE will be 200: -9890+ (200 * 100) = 10110

Total Profit: -19025+15200+10110 = 6285.00

Nifty at 8,700 on 29-Jan-15:

Sell 8,200 CE will be 500: 20975 – (500 * 100) = -29025
Buy 8,300 CE will be 400: -14800 + (400 * 100) = 25200
Buy 8,400 CE will be 300: -9890+ (300 * 100) = 20110

Total Profit: -29025+25200+20110 = 16285.00

With every 100 points up-move the profits will increase by Rs. 10,000.00.

Now let me tell you why I told earlier that “if you don’t know whether the stock will be in the best zone a few days from now or on expiry day – how can you even take a stop loss?”

The problem as you can now see from the above results is that to get into a profitable zone Nifty will have to travel through the worst zone that is from 8247 to 8500 and then some more to make a decent profit for the trader.

In real world the trader will become nervous even if Nifty is climbing up. Why? Because its a long journey for it to travel to hit the profitable zone. In desperation the trader will book a loss somewhere between 8300 and 8400 (the worst zone), never waiting for the real profits to come.

This is again a big reason as to why this trade should not be done on deep Out of The Money (OTM) options. Your total money on risk may reduce, but chances of losing money also increases. Here even after a 3% move, the trade is in loss. A deep out of the money trade may be a loser even after a 5% move.

Yes, if VIX increases substantially and expiry is a few days away, there is a chance that the trade will be in small profit even in the 8300-8500 zone. But what are the chances for that? Usually VIX decreases when Nifty is going up. This again is negative for this trade.

In view of the above, this trade is best avoidable. Look for other trades when bullish. But I hope you gained some knowledge out of this article. If yes my job is done. 🙂

Conclusion:

• In Short Call Ladder a trader sells one ITM call, and buys one ATM call and one more OTM call.
• The stock needs a significant move up to realize a profit.
• Risk-reward is good on paper, bad in real trade because the stock has to travel from a negative zone to a positive zone. The trader will almost always stop out in the negative zone.
• Avoid this trade, look for better trades when bullish.

Do share your experiences of trading a Short Call Ladder or any other ladder strategy.

COPYRIGHT INFRINGEMENT: Any act of copying, reproducing or distributing any content in the site or newsletters, whether wholly or in part, for any purpose without my permission is strictly prohibited and shall be deemed to be copyright infringement.

INCOME DISCLAIMER: Any references in this site of income made by the traders are given to me by them either through Email or WhatsApp as a Thank You message. However, every trade depends on the trader and his level of risk-taking capability, knowledge and experience. Moreover, stock market investments and trading are subject to market risks. Therefore there is no guarantee that everyone will achieve the same or similar results. My aim is to make you a better & disciplined trader with the stock trading and investing education and strategies you get from this website.

DISCLAIMER: I am NOT an Investment Adviser (IA). I do not give tips or advisory services by SMS, Email, WhatsApp or any other forms of social media. I strictly adhere to the laws of my country. I only offer education for free on finance, risk management & investments in stock markets through the articles on this website. You must consult an authorized Investment Adviser (IA) or do thorough research before investing in any stock or derivative using any strategy given on this website. I am not responsible for any investment decision you take after reading an article on this website. Click here to read the disclaimer in full.

Disclaimer | Privacy Policy | Terms and Conditions | Refund Policy | About Me | Conservative Option Course | 200+ Testimonials - What Traders Say About This Course | Contact Me

My student gets the Winner's Certificate of Zerodha 60-day Challenge - Click here and Open Stock Buy and Sell Free Account with Them Today!!!