What is Bear Put Ladder Spread Option Strategy?

Trading in bearish markets can be risky, especially if you are new to trading and are still familiarising yourself with the basics. This risk is further amplified in the options market, where the prices of derivative contracts are influenced by a wide range of factors like the underlying asset’s price, time decay and broad market factors. 

Fortunately, with the right options trading strategies, you can turn a bearish market into an opportunity to earn profits. However, strategy selection is crucial. Some bearish strategies are effective if the asset price falls steeply, while others are better suited to more moderate bearish action. 

The bear put ladder spread is one such trading technique that works best when the price of the underlying declines slightly by expiry. Check out what this strategy entails, how you can implement it and what its outcomes in different scenarios are. 

The Bear Put Ladder: An Overview

The bear put ladder is an extended variation of the bear put spread strategy. In the latter, you purchase an in-the-money (ITM) put option and sell an out-of-the-money (OTM) put option. Both options have the same expiry date and underlying asset. While this strategy does protect your finances from moderate price declines, it can result in a net debit because it involves purchasing a costlier put while selling a cheaper put. 

The bear put ladder is an options trading strategy that reduces the cost of this position by adding another trader or step to this ladder. This step involves selling another OTM put option — typically one with a lower strike price. This way, the strategy either reduces the net debit or even results in a net credit, depending on the strike prices chosen. 

Setting up the Bear Put Ladder

As you may have gathered, this options trading strategy involves three trades — namely one long position and two short positions. Let us decode these positions further to understand how the bear put ladder is constructed. 

  • Purchase an ITM Put Option

This is the foundation of the bear put ladder options trading strategy. If the price of the stock falls as expected, this position protects you from the downside and turns profitable. The strike price of this put option should be higher than the current market price of the asset. 

  • Sell Two OTM Put Options

The first step involves buying an ITM put, which can be expensive. To offset that cost and reduce the net debit, you then sell two OTM put options. The strike prices of both these options should be progressively lower than the asset’s price — meaning that one of these short put options will be further OTM than the other. 

In a more conservative variant of the bear put ladder, you could choose to sell ATM put options (or at least puts that are closer to the money). These options are more expensive than OTM puts, so you can sell them for higher premiums and reduce the cost of the trade further. However, such strike prices also narrow down the range of favourable trade outcomes. 

If you are having trouble with choosing appropriate strike prices for this options trading strategy, you can gain more insights about the process on the Samco forum. This is an online community that Samco Securities has created for traders to share knowledge and insights based on real experiences. The best part is that the Samco forum, like all other advanced tools and features offered by the brokerage firm, is available free of cost to Samco customers. 

Key Formulas in the Bear Put Ladder

Before implementing the bear put ladder, you must know how to quantify the best and worst-case outcomes from the trade. The formulas outlined below can help you assess the total cost, maximum profit and maximum loss for this options trading strategy

  • Cost of the Trade

The total cost of setting up the bear put ladder is the net of the premium paid for the long put and the premiums received for the two short puts. Generally, the premiums received work to partially offset the premium paid, thereby reducing the net debit for the trade. However, if the premiums received exceed the premium paid, you may even get a net credit for the trade.

  • Maximum Gain

The maximum profit you can earn from your bear put ladder can be computed using this formula: 

Maximum Gain = Higher Long Put Strike Price — Middle Short Put Strike Price — Net Premium Paid

The bear put ladder attains maximum profitability if the asset price falls moderately and is between the strike prices of the short OTM puts. Knowing this metric gives you a better idea of the best possible outcome from the trade. 

  • Maximum Risk

This options trading strategy may be unprofitable in two cases — if the asset price rises above the long put’s strike price or if the price falls substantially and goes below the second short put’s strike price. 

If the asset price rises above the long put, all three options expire worthless and the loss is limited to the net premium. However, if the asset price falls below the lowest strike price, the loss can be unlimited depending on how much the price declines. 

An Example of the Bear Put Ladder Strategy 

Let’s say a company’s stock is currently trading at Rs. 300. You expect it to fall moderately over the short term, so the bear put ladder strategy may be suitable here. To set up this trade, you buy/sell put options with a lot size of 100 shares as outlined below:

  • Trade 1: Buy an ITM put with a strike of Rs. 310 by paying a premium of Rs. 16 per share (total premium of Rs. 1,600)
  • Trade 2: Sell one OTM put with a middle strike of Rs. 290 for a premium of Rs. 6 per share (total premium of Rs. 600) 
  • Trade 3: Sell another further OTM put with a lower strike of Rs. 280 for a premium of Rs. 3 per share (total premium of Rs. 300)

The total cost of setting up this trade is the net premium paid, which is Rs. 700 (1,600 — 600 — 300). 

  • Scenario 1: Stock Declines Moderately at Expiry 

Assume the stock declines slightly from Rs. 300 at the time of setting up this options trading strategy to Rs. 282. In this case, here is what the outcomes of each of the three trades will be:

Trade 

Explanation

Computation

Profit or (Loss)

Trade 1

This put option is profitable for you since you are the buyer of the options contract.

[(Rs. 310 — Rs. 282) x 100 shares] — Rs. 1,600

Rs. 1,200

Trade 2

This put option is profitable for the buyer. However, since you are the options seller, it will be a loss-making position for you. 

Rs. 600 — [(Rs. 290 — Rs. 282) x 100 shares]

(Rs. 200)

Trade 3

The further OTM short put with a strike price of Rs. 280 will expire worthless, leaving you with the premium received. 

 

Rs. 300

Total Outcome of the Trade

 

Rs. 1,300

So, the net profit from this trade will be Rs. 1,300 (i.e. Rs. 1,200 — Rs. 200 + Rs. 300). This also aligns with the maximum gain formula discussed earlier in the article. 

  • Scenario 2: Stock at Expiry is Above the Higher Strike 

If the stock price rises at expiry to, say Rs. 315. This means that all three options will expire worthless. Your loss will be limited to the net premium paid, i.e. Rs. 700. 

  • Scenario 3: Stock at Expiry is Below the Lower Short Put’s Strike

The bear put ladder options trading strategy is also a loss-making trade if the price decline is substantial. So, let us take up a scenario where the stock price falls by a large amount from Rs. 300 to Rs. 265 — well below the lower strike price attributed to the further OTM short put. 

In this case, here is what the outcomes of each of the three trades will be:

Trade 

Explanation

Computation

Profit or (Loss)

Trade 1

This put option is profitable for you since you are the buyer of the options contract.

[(Rs. 310 — Rs. 265) x 100 shares] — Rs. 1,600

Rs. 2,900

Trade 2

This put option is profitable for the buyer. However, since you are the options seller, the outcome from this trade may be the opposite (depending on the premium received).

Rs. 600 — [(Rs. 290 — Rs. 265) x 100 shares]

(Rs. 1,900)

Trade 3

This put option is also valuable for the buyer but may be a loss for you, the seller, depending on how much premium you received for the trade.

Rs. 300 — [(Rs. 280 — Rs. 265) x 100 shares]

(Rs. 1,200)

Total Outcome of the Trade

 

(Rs. 200)

Conclusion

This concludes our guide to the bear put ladder options trading strategy. You can implement it when you expect a minor price dip in a stock. To finetune this strategy further and align it with your market outlook, you may need further insights and guidance. On the Samco forum, you can obtain all these details and more. With dedicated spaces to discuss various aspects of trading such as futures and options, IPO, stock updates and Samco’s proprietary ‘My Trade Story’ feature, the Samco forum gives you the safe space required to understand and decode your past trades, so your future positions in the market are more likely to be successful.

Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING.
The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008
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