Last updated on April 7th, 2022 , 07:05 am
TAKEAWAYS
- The long call ladder (AKA bull call ladder) is comprised of a traditional long call spread with an additional out-of-the-money call sold.
- Maximum loss on the long call ladder strategy is infinite.
- Maximum profit for the long call ladder spread is Middle Short Strike Price – Strike Price of Long Call – Total Debit Paid.
- Max profit occurs when the underlying security is trading between the strike prices of the two calls sold.
- Due to the 1×2 long call to short call ratio, the margin is very high for all ladder trades.
The long call ladder (also known as the bull call ladder), is a moderately bullish options trading strategy.
The long call ladder has a lot in common with the bull call spread (long call spread), with a few very important differences.
The chief distinction between these two strategies lies in the risk involved. While the bull call spread is a defined risk strategy, the bull call ladder has unlimited risk.
This unlimited risk lay in the structure of the ladder strategy, which consists of one long call and two short calls. Whenever you have unhedged calls, your risk is infinite.
Let’s break the strategy down!
Bull Call Ladder Profile
| Long Call Ladder | |
|---|---|
|
Market Direction |
Moderately bullish |
|
Trade Setup |
Long 1 ITM Call |
|
Maximum Profit |
Middle Short Strike Price – Strike Price of Long Call – Total Debit Paid. Occurs when the price of the underlying asset is trading between the strike pries of the two short calls at expiry. |
|
Maximum Loss |
Maximum Loss #1: When stock is below long call strike price at expiration, max loss is net debit paid. Maximum Loss #2: When stock rallies beyond the highest strike price sold, max loss is infinite |
|
Breakeven Point |
1.) Upper Breakeven: Upper Strike + Middle Strike – Lower Strike – Premium Paid 2.) Lower Breakeven: Long Call Strike Price + Total Debit Paid |
Bull Call Ladder vs Bull Call Spread
The best way to understand the ladder strategy is by comparing it to the traditional bull call spread.
The bull call spread is a bullish, defined-risk, limited profit options strategy. The below graph shows the profit/loss profile for this trade at expiration:
The bull call spread consists of two call options:
- Long 1 Call Option at Lower Strike Price
- Short 1 Call Option at Higher Strike Price
Since we are both long a call and short a call option in the same expiration date cycle, this strategy has defined risk: the most we can lose is the debit paid to enter the trade.
But what if you believed a stock was indeed going to go up, but not past a certain level? Couldn’t you sell an additional call at this level in order to generate a little extra income from the trade?
In options trading, you can do whatever you want. You can combine as many calls and puts and expiration cycles as you desire.
So what would this graph look like if we decided to add an extra short call at the end of this trade?
Long Call Ladder Visualized
The below image shows a traditional bull call spread with an extra short call added at the tail end. The result? The long call ladder (or bull call ladder).
- Long 1 Call Option at Low Strike Price
- Short 1 Call Option at Middle Strike Price
- Short 1 Call at High Strike Price
I like to think of the bull call ladder as the greedy man’s long call spread. If you are not content with the maximum profit from the original call spread (Strike Price of Short Call – Strike Price of Long Call – Net Premium Paid) you could sell an extra call.
This third short call must my further out-of-the-money than the first short call sold.
As long as the stock stays between the strike prices of your short calls, you will achieve both the maximum profit from the original spread (equation above) and the credit received from that extra out-of-the-money call you sold.
The downside? Your risk is now infinite, as illustrated in that downward-sloping red arrow in the above chart.
Let’s take a look at an example next.
Long Call Ladder Trade Example
In this example, we are going to look at a long call ladder on Apple (AAPL) stock. Here are our trade details.
AAPL Long Call Ladder:
- AAPL Stock Price: $170
- Days to Expiration: 9
- Long Call Strike/Debit: 170/$2.95
- Short Call #1 Strike/Credit: 175 / $0.96
- Short Call #2 Strike/Credit: 180 / $0.27
- Net Debit: (2.95-0.96-0.27) = 1.72
- Lower Breakeven: $171.72
- Upper Breakeven: $183.28
- Max Loss: Infinite
- Max Profit: $328
So we bought the 170/175 call spread for $1.99 (2.95-0.96), then tacked on an extra short call for 0.27. This extra credit received reduced the cost of our trade by 0.27, bringing the new trade debit down to $1.72. Don’t get too overwhelmed by the numbers.
Our maximum profit here is simply the width of the traditional call spread (5 points), minus the net debit paid (1.72). This gives us 5 – 1.72, or maximum profit potential of $3.28.
Since we have a naked short call, our maximum loss is infinite on the upside, but limited to the cost of the trade on the downside.
To help better understand our trade, let’s analyze it visually:
As we can see, we will achieve maximum profit when AAPL is trading between about 175 and 180 on expiration.
For breakeven, we can expand these bounds to $171.72 and $183.28.
Let’s fast-forward to expiration day and see how our trade did!
Winning AAPL Long Call Ladder at Expiration
- AAPL Stock Price: $170 –> $175
- Days to Expiration: 9 –> 0
- Long Call Strike/Debit: 170/$2.95 –> $5
- Short Call #1 Strike/Credit: 175 / $0.96 –> $0
- Short Call #2 Strike/Credit: 180 / $0.27 –> $0
- Spread Value (5 + 0 + 0) = 5
If on expiration day at the close AAPL is trading at $175, we will have achieved maximum profit on the trade of $328. Why?
Our long 170 call has increased in value from $2.95 to $5. That’s a profit of $205. Additionally, both of the calls we sold expired worthless (one was at-the-money at expiration, which we will call worthless for simplicity). The credit we received for these calls was $0.96 + $0.27. That gives us a credit received of $1.23, or $123.
So what is a profit of $205 plus a profit of $123? $328.
But what if this trade didn’t go our way? What if AAPL kept rising inexorably in value? Let’s check out that trade outcome next.
Losing AAPL Long Call Ladder at Expiration
We said before that the long call ladder is a moderately bullish options trading strategy. This next hypothetical trade outcome will show why. Here, AAPL has risen in value to $190/share in value on expiration day.
- AAPL Stock Price: $170 –> $190
- Days to Expiration: 9 –> 0
- Long Call Strike/Debit: 170/$2.95 –> $20
- Short Call #1 Strike/Credit: 175 / $0.96 –> $15
- Short Call #2 Strike/Credit: 180 / $0.27 –> $10
- Spread Value (20 – 15 – 10) $-5
Traditional bull call spreads are great because you always know your maximum loss scenario – the total debit paid. With long call ladders, this can be much more complicated – and risky.
In this trade example, the short options in our trade have increased significantly in value. If we never added that extra 180 short call, we would have achieved a maximum profit on the traditional call spread component of our trade of $5 ($20-$15 = $5 profit).
But we did indeed sell that extra call. Its value at expiration was $10. That $10 must be subtracted from our profit of $5 on the call spread. The result is a negative spread value of $-5 on expiration. That means we lost $500 on the trade.
Remember, our maximum profit in this scenario was only $328!
Theta (Time Decay) in Bull Call Ladder Spreads
The bull call ladder has a complicated relationship with the options Greek theta.
Theta, or time decay, tells us how fast the value of an option declines on a daily basis in an environment of stable stock price and volatility.
In the bull call ladder:
- Theta is negative when the underlying is trading both below the lower breakeven and above the higher breakeven.
- Theta is positive when the underlying is trading between these two breakeven prices.
Bull Call Ladder Spread: Choosing Strike Prices
Perhaps the most important part of trading options is choosing the right strike prices.
For a lesson on choosing strike prices on vertical spreads, check out our article here.
Once you determine the strike prices of the traditional call spread component of the ladder strategy, you must go one step further and choose the strike price of that last, very risky, out-of-the-money call option.
Here are three important reminders in your selection process:
- The further an option is sold out-of-the-money, the greater that option has of expiring worthless.
- Options sold closer to being in-the-money will result in a higher credit, thus a higher maximum profit potential for the ladder.
- Additionally, options sold closer to being in-the-money will have a lower probability of success that out-of-the-money options.
The below image, taken from the tastyworks trading platform, shows the traditional strike price layout on an options chain for a bull call ladder spread. But remember, you can get as creative as you want with options!
Traditional Bull Call Ladder Setup
Bull Call Ladder Spread: Pros and Cons
In order to adequately understand the pros and cons of the long call ladder, we must compare this strategy to the less sophisticated bull call spread.
👍 Bull Call Ladder Pros
- When compared to the traditional long call spread, the long call ladder spread expands the profit area by the credit taken in from the extra call.
- The long call ladder spread also has a lower breakeven price than the long call spread on account of the extra premium taken in.
👎 Bull Call Ladder Cons
- When compared to the traditional long call spread, the long call ladder spread requires much more margin. This is because the highest strike price call is sold naked.
Traditional 175/180 Bull Call BP Effect
175/180/185 Bull Call Ladder BP Effect
- When compared to the traditional long call spread, the long call ladder spread requires much more margin. This is because the highest strike price call is sold naked. Opportunity costs must be taken into account when utilizing this strategy.
Bull Call Ladder Spread: Is It Worth It?
Personally, I do not believe the profit/loss profile of the bull (long) call ladder spread makes the trade worthwhile.
What we can not quantify here is the anxiety one feels when being in a position that has unlimited loss potential. This is particularly worrying when the maximum profit is capped at a relatively low level.
When you trade bull call ladder spreads, you are trading naked call option contracts. It is that simple. You can use stop loss orders on that extra short call to mitigate risk, but this by no means removes risk.
In a nutshell, the bull call ladder is an advanced options trade, and best avoided by beginners.
How strong is your stomach?
*Before trading options, traders should read the Characteristics and Risks of Standardized Options, or the Options Disclosure Document (ODD).*
