Short Put Ladder Strategy Explained

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.

Let’s try to understand with an example:

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:

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.