A short put ladder is a stock options strategy that provides almost unlimited opportunity if the stock in question falls in price. Traders use this strategy first of all to profit from falling stock prices. And, it is used when a stock’s implied volatility drops unexpectedly and the trader expects volatility to rise again. The trade includes three puts that are respectively in-the-money, at-the-money, and out-of-the-money. You sell the in-the-money put and buy the other two. All purchases are for the same stock and for the same expiration date. An alternative setup is to sell an at-the-money put and buy an out-of-the-money put and a far out-of-the-money put.
What Does It Mean to Short a Put Option?
A short put is when you open a trade by selling a put. When this is the only part of the trade it is also called an uncovered or naked put. If the stock in question does not fall in price the trader gains the premium paid for the options contract minus fees and commissions. The risk of an uncovered put is the entire price of the stock as the trader is obliged to sell the stock at whatever price it falls to. Thus, professional traders use strategies like a short put ladder. The trade is ideally set up so that the profit from selling the in-the-money or at-the-money put is greater than the cost of the two purchased puts. And, when the stock does fall the “extra” purchased put can provide an impressive profit.
Is a Short Put Bearish?
The clean answer is, yes. You purchase puts when you believe that a stock will go down in price. You sell a put when you believe that the stock will remain at the same price or go up. The difference between a naked put or short put and a short put ladder is that the first put that you buy prevents the loss from the one that you sold from being excessive. The second put that you purchase gives you a profit in the case of a significant drop in the price of the stock.
Profit, Loss, and Break Even With a Short Put Ladder
If the stock in question closes at or above the strike price of the short put, your profit will be the premium received minus what you paid for the two puts that you purchased minus fees and commissions. If the stock falls below the strike price of the short put you will lose money down to the strike price of the upper put that you purchased. Depending on how far apart the in-the-money and out-of-the-money puts are, you may simply lose your profit from the differential in premiums. If the spacing is excessive, you may have a substantial loss but not an unlimited one as the profit from the first purchased put will offset the loss of the short put. And, if the stock falls to the strike price of the lower purchased put, your gains will eventually offset any initial losses and then produce significant gains.
Setting Up a Short Put Ladder
Professionals use a short put ladder when volatility has fallen and the trader expects it to rise again with movement to the downside. The first goal of this trade is to make enough money by selling the put at the top price to offset the costs of purchasing two puts and paying fees and commissions. Thus, you will make a profit if the stock stays even or goes up. The next goal is to choose strike prices for the purchased puts that fulfill the goal of not losing money when the stock does not move in price and do not cause an excessive loss when the stock goes down. Working with the Pros at Top Gun Options will provide you with the insights to be able to do this profitably.