Short Put Ladder Strategy Explained
01 Jun 2017
Nilesh Jain
New Page 1
Short Put Ladder Strategy
A Short Put Ladder is the extension of Bull Put spread; the only
difference is of an additional lower strike bought. The purpose of buying the additional
strike is to get unlimited reward if the underlying asset goes down.
When to initiate a Short Put Ladder
A Short Put Ladder should be initiated when you are expecting big
movement in the underlying asset, favoring downside movement. Profit potential will be
unlimited when the stock breaks lower strike price. Also, another opportunity is when the
implied volatility of the underlying asset falls unexpectedly and you expect volatility to
go up then you can apply Short Put Ladder strategy.
How to construct Short Put Ladder?
A Short Put Ladder can be created by selling 1 ITM Put, buying 1 ATM
Put and buying 1 OTM Put of the same underlying asset with the same expiry. Strike price
can be customized as per the convenience of the trader. A trader can
also initiate the Short Put Ladder strategy in the following way - Sell
1 ATM Put, Buy 1 OTM Put and Buy 1 Far OTM Put.
Strategy |
Sell 1 ITM Put, Buy 1 ATM Put and Buy 1
OTM Put |
Market Outlook |
Significant movement (lower side) |
Upper Breakeven |
Strike price of Short Put - Net Premium
Received |
Lower Breakeven |
Addition of two Long Put strikes - Strike Price of Short
Put + Net Premium Received |
Risk |
Limited (expiry between upper and lower
breakeven). |
Reward |
Limited to premium received if stock surges above higher
breakeven
Unlimited if stock falls below lower breakeven.
|
Margin required |
Yes |
Let’s try to understand with an example:
Nifty Current spot price (Rs) |
9400
|
Sell 1 ITM Put of strike price (Rs) |
9500
|
Premium received (Rs) |
180
|
Buy 1 ATM Put of strike price (Rs) |
9400
|
Premium paid (Rs) |
105
|
Buy 1 OTM Put of strike price (Rs) |
9300
|
Premium paid (Rs) |
45
|
Upper breakeven |
9470
|
Lower breakeven |
9230
|
Lot Size |
75
|
Net Premium Received (Rs) |
30
|
Suppose Nifty is trading at
9400. An investor Mr. A is expecting a significant movement in the Nifty with a slightly
more bearish view, so he enters a Short Put
Ladder by selling 9500 Put strike price at Rs 180, buying 9400 strike
price at Rs 105 and buying 9300 Put for Rs 45. The net premium received to initiate this trade is Rs 30. Maximum loss from the
above example would be Rs 5250 (70*75). It would only occur when the underlying asset
expires in the range of strikes bought. Maximum profit would be unlimited if it breaks
lower breakeven point. However, profit would be limited up to Rs 2250(30*75) if it moves
above the higher breakeven point.
For the ease of understanding, we did not take in to account commission
charges. Following is the payoff chart and payoff schedule assuming different scenarios of
expiry.
The Payoff chart:
The Payoff Schedule:
On Expiry NIFTY closes at
|
Payoff from 1 ITM Put sold (9500) (Rs)
|
Payoff from 1 ATM Puts Bought (9400) (Rs)
|
Payoff from 1 OTM Put Bought (9300) (Rs)
|
Net Payoff (Rs)
|
8700
|
-620
|
595
|
555
|
530
|
8800
|
-520
|
495
|
455
|
430
|
8900
|
-420
|
395
|
355
|
330
|
9000
|
-320
|
295
|
255
|
230
|
9100
|
-220
|
195
|
155
|
130
|
9200
|
-120
|
95
|
55
|
30
|
9230
|
-90
|
65
|
25
|
0
|
9300
|
-20
|
-5
|
-45
|
-70
|
9400
|
80
|
-105
|
-45
|
-70
|
9470
|
150
|
-105
|
-45
|
0
|
9500
|
180
|
-105
|
-45
|
30
|
9600
|
180
|
-105
|
-45
|
30
|
9700
|
180
|
-105
|
-45
|
30
|
9800
|
180
|
-105
|
-45
|
30
|
Impact of Options Greeks:
Delta: At the initiation of trade, Delta of the Short Put Ladder
will be negative, indicating of a decent profit potential if the underlying asset moves
lower.
Vega: Short Put Ladder has a positive Vega. Therefore, one should
initiate Short Put Ladder spread when the volatility is low and expects it to rise.
Theta: A Short Put Ladder has negative Theta position and therefore
it will lose value due to time decay as the expiration approaches.
Gamma: This strategy will have a long Gamma position, which
indicates any significant downside movement, will lead to unlimited profit.
How to manage Risk?
A Short Put Ladder is exposed to limited loss; hence it is advisable to
carry overnight positions.
Analysis of Short Put Ladder Strategy:
A Short Put Ladder is best to use when you are confident that an underlying security will move significantly lower. Another scenario wherein
this strategy can give profit is when there is a surge in implied volatility. It is a limited risk and an
unlimited reward strategy only if movement comes on the lower side or else reward would
also be limited.