What is a Christmas Tree?

A Christmas tree is an options trading spread strategy achieved by buying and selling six call (or 6 put) options with different strikes but the same expiration dates for a neutral to bullish forecast. This is termed a long call Christmas tree when using calls or a put Christmas tree when using put options. The strategy is also available long (bullish) or short, (bearish).

This spread is essentially the combination of a long vertical spread and two short vertical spreads.

Key Takeaways

  • A Christmas tree is an options spread strategy that involves 6 call (or put) options: buying one ATM call (put) selling 3x calls (puts) two strikes out of the money and then buy 1 more call (put) three strikes out of the money.
  • This strategy pays off with a neutral to slightly bullish outcome in the underlying security.
  • Christmas trees can be constructed with either all calls or all puts, and may be structured as either long or short.

How Christmas Trees Work

The Christmas tree name comes from the strategy's very loose resemblance of a tree when viewed on an options chain display. The connection is tenuous, at best.

Christmas trees are very similar to butterfly spreads in that they use multiple vertical spreads to box in a desired potential return. The difference is that one of the spreads skips a strike price, which introduces a directional bias.

The regular, or long Christmas tree with calls (sometimes referred to simply as a 'call tree'), involves buying one call option with an at-the-money strike, skipping the next strike and then selling three options with the following strike. Finally, buy two more calls with the next higher strike. The 1-3-2 structure supposedly appears as a tree.

The strategy profits from a small increase in price of the underlying asset and maxes when the underlying closes at the middle option strike price at options expiration.

  • Maximum profit equals middle strike minus lower strike minus the premium.
  • Maximum loss is the net debit paid for the strategy.
  • Breakeven occurs at the lowest strike plus the premium paid or the highest strike minus the half the premium. 

Time decay is on the holder's side as the holder wants all options except the lowest to expire worthless.

Examples

Long Christmas Tree With Calls

For example, with the underlying asset at $50.00:

  • Buy 1 call strike price 50.00
  • Sell 3 calls strike price 54.00
  • Buy 2 calls strike price 56.00

Long Christmas Tree with Puts

With this strategy, the holder is neutral to bearish. Sometimes referred to simply as a 'put tree'.

  • Buy 1 put strike price 50.00
  • Sell 3 puts strike price 48.00
  • Buy 2 puts strike price 46.00

Maximum profit is at an underlying asset price of 48.00 at expiration.

  • Maximum profit equals middle strike minus higher strike minus the premium.
  • Maximum loss is the net debit paid for the strategy.
  • Breakeven occurs at the lower strike plus the half the premium paid or the highest strike minus the premium. 

Maximum loss is the premium paid to initiate the strategy.

Short Christmas Tree with Calls

Short strategies should result in a net credit to the account when initiated. This strategy profits when the underlying asset moves by a minimum direction in either direction but it is capped. The bias is bearish because it does not take much of a move lower in the underlying to make the strategy profitable. However, a larger move higher may also result in profit

  • Sell 1 call strike price 50.00
  • Buy 3 calls strike price 54.00
  • Sell 2 calls strike price 56.00

The maximum profit is the net credit received.

Short Christmas Tree with Puts

This strategy results in a net credit to the account and profits when the underlying moves by a minimum in either directions. Profits come quicker with a smaller upside move although a larger downside move would also be profitable. therefore, this strategy leans bulls.

  • Sell 1 put strike price 50.00
  • Buy 3 puts strike price 48.00
  • Sell 2 puts strike price 46.00

The maximum profit is the net credit received.