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What is the 1 1 1 Option Strategy?

Published in Options Trading Strategy 3 mins read

The "1 1 1 option strategy" specifically refers to a Bear Call Ladder strategy executed in a 1:1:1 ratio, meaning a precise combination of selling and buying call options at different strike prices. This structured approach is employed by traders who hold a moderately bearish to neutral view on the underlying asset's price movement.

Understanding the Bear Call Ladder and the 1:1:1 Ratio

The Bear Call Ladder is an advanced options strategy involving three different call options with the same expiry date but different strike prices. The "1:1:1" ratio dictates the exact number of contracts for each leg of the strategy.

Components of the 1:1:1 Bear Call Ladder

For every one unit of the strategy, a trader performs the following actions:

  • Sell 1 In-The-Money (ITM) Call Option: This is the foundational bearish leg, generating upfront premium. The ITM call has a strike price below the current market price of the underlying asset.
  • Buy 1 At-The-Money (ATM) Call Option: This leg helps to define the risk and often reduces the net credit received initially. The ATM call has a strike price very close to the current market price.
  • Buy 1 Out-Of-The-Money (OTM) Call Option: This is the "ladder" component, purchased at a higher strike price than the ATM call. It helps to cap potential losses if the underlying asset moves significantly higher than anticipated, turning the strategy into a potential limited profit and unlimited risk scenario (without this long OTM call). The OTM call has a strike price above the current market price.

The arrangement of these three legs creates a specific risk/reward profile.

Market View and Purpose

Traders typically implement the 1:1:1 Bear Call Ladder when they expect the underlying asset's price to:

  • Decline moderately: The initial bearish stance profits from a price drop.
  • Remain stable: If the price stays within a certain range, the strategy can still be profitable due to time decay.
  • Slightly increase: There's a profit zone even if the price increases up to a certain point.

The strategy offers a defined maximum profit if the price falls significantly or expires between the ATM and OTM strikes. However, it carries unlimited risk if the price rises sharply above the highest OTM strike, making it crucial for traders to understand the payoff structure before entering.

Practical Insights

  • Net Credit/Debit: Depending on the chosen strike prices and current volatility, the 1:1:1 Bear Call Ladder can be initiated for a net credit or a net debit. Typically, it's structured to receive a net credit.
  • Risk Management: Despite the presence of the long OTM call, substantial upward movement in the underlying asset can lead to significant losses. Close monitoring and potential adjustments or exits are essential.
  • Flexibility in Ratios: While 1:1:1 is a classic combination, other ratios like 2:2:2 or 3:3:3 (scaling up the number of contracts proportionally for each leg) are also possible, allowing traders to adjust their exposure based on their capital and market conviction.
  • Strategy Category: It falls under vertical spread strategies, with an added third leg that gives it the "ladder" characteristic.

For more detailed information on option strategies, including the Bear Call Ladder, you can refer to educational resources like Varsity by Zerodha.