A ladder option is an exotic option that locks in partial profits once the underlying asset reaches predetermined price levels or "rungs.
Ladder options come in put and call varieties. Do not confuse ladder options, which are specific types of options contractswith long call ladders, long put ladders, and their short counterparts, which are options strategies that involve buying and selling multiple options contracts simultaneously.
How a Ladder Option Works Ladder options are similar to traditional option contracts that give the holder the right, but not the obligation to buy or sell the underlying asset at a predetermined price at or by a predetermined date.
However, a ladder option adds a feature that allows the holder to lock in partial profits at predetermined intervals.
Trade options FREE For 60 Days when you Open a New OptionsHouse Account Limited Downside Risk, Unlimited Risk to the Upside Losses is limited to the initial debit taken if the stock price drops below ladder options lower breakeven point but large unlimited losses can be suffered should the stock price makes a dramatic move to the upside beyond the upper breakeven point. The breakeven points can be calculated using the following formulae. Note: While we have covered the use of this strategy with reference to stock options, the long call ladder is equally applicable using ETF options, index options as well as options on futures.
These intervals are fittingly called "rungs" and the more rungs the price of the underlying asset crosses, the more profit locks in. The holder keeps profits based on the highest rung achieved ladder options calls or the lowest rung achieved for puts regardless if the price of the underlying crosses back below for calls or above for puts those rungs before expiration.
The bull call ladder ladder options is best used when you are confident that a security is going to increase in price, but you don't believe it will increase by a huge amount. It's an alternative to the bull call spread, one of the most commonly used trading strategies, that's typically used to lower the amount of capital required to establish the position. It generally results in an upfront cost, but it can be adjusted so that you receive an upfront credit instead. How to Establish the Bull Call Ladder Spread The bull call ladder spread is a little more complex than the bull call spread, ladder options it only involves one extra transaction for a total of three transactions. These three transactions can be made simultaneously or, if you prefer, you can use legging to carry them out at different times and possibly increase the potential profits.
Because the holder earns non-returnable partial profits as the trade develops, total risk is much lower than for traditional vanilla options. The trade-off, of course, is that ladder options are more expensive than similar vanilla options.
Rungs ladder options set at 60, 65, and If the underlying price reaches 62, the profit locks calculation of a real option at 5 rung minus strike or 60 - If the underlying reaches 71, then the locked in profit increases to 15 new rung minus strike or 70 - 55even if the underlying falls below these levels before the expiration date.
As with vanilla options, there is time value associated with ladder options. If the price of the underlying falls below ladder options of the triggered rungs, again for calls, it almost does not matter to the price of the option because the partial profit is guaranteed.