Long Call Ladder
Risk: unlimited
Reward: limited
General Description
Entering a long call ladder entails buying (1) lower strike call, selling (1) middle strike call and selling (1) higher strike call (same expiration month). It's can be thought of as a short call ratio spread which staggers the short calls instead of using the same strike. It's also similar to a lower strike bull call spread with an extra naked call at a higher strike.
(draw a long call ladder risk diagram here)
The Thinking
You're confident a stock will trade in a tight range or possibly move up slightly. A bull call spread will profit in such a situation because the decline in value of the long call will be more than offset by the time decay of the short call. Then an additional call is sold at a higher strike. This helps finance the trade and results in a more favorable breakeven level.
Example
XYZ is at $55.00. You buy (1) 50 call for $7.00 and sell (1) 55 call for $3.00. This is a bull call spread. Then you sell (1) 60 call for $1.00. Your net debit is $3.00.
Below the lowest strike, all calls expire worthless, and your loss is the net debit paid when the trade was initiated.
Above the highest strike, all calls expire in-the-money. The profit from the long call will be canceled out by the loss from one of the short calls, and then the remaining short call will increase in value point-for-point with the underlying. For example, at $65, the 50 call will be worth $15 ($8.00 gain), the 55 call will be worth $10 ($7.00 loss) and the 60 call will be worth $5 ($4.00 loss). The net of this is a $3.00 loss.
Between the two higher strikes ($55 and $60), max profitability is achieved. As an example, at $55, the 50 call will be worth $5 ($2.00 loss), and the 55 and 60 calls will expire worthless ($3.00 gain and $1.00 gain). The net of this a $2.00 profit.
The PL chart below graphically shows where this trade will be profitable and at a loss.
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