Bull Call Ladder
Description
The
Bull Call Ladder is an extension to the Bull Call Spread. By shorting another
call at a higher strike price, the position assumes uncapped risk potential if
the stock soars upwards. The problem is that now its not totally clear if we
have a bullish or bearish strategy, so we have to designate it as a direction
neutral strategy! We’d love the stock to rise to the middle strike price (the
first Short Call) but not above the higher short call strike price. Anywhere in
between the middle and higher strike is ideal.
Because
of the dangers of uncapped risk, this strategy becomes more appropriate for a
short-term income trade. The net effect of the higher short strike is to reduce
the cost and break even of the Bull Call Spread and adjust the directional
nature of the trade. The higher call strike prices are further OTM and will
therefore have lower premiums than the lower strike bought call.
So,
in summary, if the stock falls below the lower (buy) strike, you can make a
loss;if the stock rises to anywhere between the middle and upper (short)
strikes, you make your maximum profit; if the stock rises above the highest
strike, then you can make unlimited losses. The extra leg also ensures that you
may have two break even points.
Market
Opinion
Neutral.
P/L
When
To Use
Use
this strategy when you want to increase income in a neutral to slightly bullish
environment and you think the stock will experience limited volatility in the
short term.
Example
XXXX
is trading at $26.10 on May 11, 2011.
Buy
June 2011 25 strike call for $1.60.
Sell
June 2011 $27.50 strike call for $0.20.
Sell
June 2011 30 strike call for $0.10.
Benefit
The
benefit of doing this trade is that it costs less than a Bull Call Spread.
Risk
vs. Reward
The
risk of this strategy is uncapped since you sold more calls then you bought.
The reward is the difference between the lower and middle strike prices less
your net debit or plus your net credit.
Net
Upside
The
lower strike sold calls cap the upside.
Net
Downside
Uncapped
downside.
Break
Even Point
Break
even up: higher strike minus lower strike minus net debit.
Break
even down: lower strike plus net debit
Effect
Of Volatility
Minimal
to low effect.
Effect
Of Time Decay
Negative.
At the lower strike price has a negative effect.
Alternatives
Before Expiration
In
the event that the stock drops under the stop loss, sell the long call or close
out the entire position.
Alternatives
After Expiration
Close
out the position by buying back the calls sold and selling the calls bought.
