Exotic options strategies are generally reserved for the experienced options trader, but traders just starting out can employ them as well, if they understand the associated risks. After all, so-called exotic option strategies are nothing more than plain-vanilla options structured in a way to express a market viewpoint.
The Jade Lizard is one of the more popular options-trading strategies. It’s a relatively simple move best suited for when a trader has a neutral to bullish outlook for a given security and markets are range-bound and moving sideways, but with potential to move higher. The Jade Lizard strategy combines a short put and a short call spread. We’ll use a real-life Jade Lizard example to potentially give you another tool for your own trading.
- A Jade Lizard is a relatively simple and popular option strategy best deployed when the trader has a neutral (i.e., sideways or range-bound) to bullish view of a given security.
- The strategy is a premium-only option trade, meaning that the maximum gain is the amount of premiums taken in when implementing the strategy.
- There is the potential for significant downside risk with the Jade Lizard strategy, as it involves selling a naked put.
- The ideal outcome is for the price at expiration to be between the lower naked put and the upside call, allowing the options to finish worthless and the trader to keep the premium earned.
Inside a Jade Lizard Strategy
The Jade Lizard strategy is best employed when the trader has a neutral to bullish view on a particular stock. The strategy is a net option premium trade, where the maximum profit is the total premiums received for selling and buying the three legs of the strategy.
Let’s take a look at a Jade Lizard strategy using the hypothetical stock of Company XYZ, which is currently trading at $48 a share.
To apply a Jade Lizard strategy with XYZ, the trader will sell an out-of-the-money (OTM) put at $45 a share, and at the same time sell an OTM call spread at $52 and $53 (selling an OTM $52 call and buying an OTM $53 call), all for the same expiration date. The key is that the total premium collected should be greater than the amount between the two calls in the call spread—in this case, $1.
To lay it out in greater detail, the hypothetical Jade Lizard is composed of the following three transactions, all expiring at the same time:
- Sell 1 XYZ 52 call for $1.50 in premium
- Buy 1 XYZ 53 call for $1.10 in premium
- Sell 1 XYZ 45 put for 90 cents in premium
The net premium gained is $1.30 (+1.50-1.10+90 cents), or $130 per 100 shares in each contract (a typical options contract controls 100 shares). (Commissions are not included.)
Maximum Upside Potential
Your maximum profit would be the $130 collected in premium if the underlying stock price stays in the sweet spot between the downside put at $45 and below the lower of the two calls—in this case, $52 a share. At expiration, if the market price should exceed the higher call at $53, you’ll lose $1 on the call spread, or $100 per contract, leaving you with $30 in remaining collected premium. Note also that the naked $45 put would expire worthless, eliminating downside risk.
Maximum Downside Risk
The maximum downside risk is theoretically that the stock price falls to zero, leaving you long at the $45 price level by virtue of the sold naked put.
For example, a standing stop-loss order at $43 a share would limit the downside loss to only $200, for a net loss of $70 ($130 in premiums collected - $200 in stock price loss = -$70).
The breakeven point on the downside for this Jade Lizard strategy is the difference between the $1.30 premium collected minus the $45 naked put, or a share price of $43.70. On the upside, if the price closes above the $53 upper call, you’ll lose $1 on the call spread, or $100 per contract, still leaving you with $30 per contract as a profit.
If I employ a Jade Lizard strategy, can I just sit back and take the premium earned?
In most cases, yes, as long as the market stays sideways between your option strikes. If, on the other hand, the market should decline below the sold put option, then you’ll have a long position that you’ll need to manage.
Why is it called Jade Lizard?
The strategy gets its name from its profit and loss profile, which resembles a long-tailed lizard.
Can I sell out of the strategy before expiration?
Yes, you would need to unwind each option leg of the strategy to fully exit the strategy. The option profile is theta positive, meaning that the option strategy as a whole gains in value as the expiration date approaches.
How do I select my strike prices?
Technical analysis is likely your best bet to identify the sideways range that you’re looking to exploit. Looking back several days or weeks should reveal a developing or existing range. If there isn’t an obvious range, then it’s probably not the right time for the Jade Lizard strategy.
The Bottom Line
As a strategy, the Jade Lizard allows relatively aggressive traders the opportunity to get off the sidelines and make some money during a period of range trading or consolidation. The strategy also presumes that prices eventually will move higher.
The Jade Lizard is a net premium trade, meaning that the maximum profit is the amount of premium collected by selling the various options that make up the strategy. The strategy has significant downside risk by virtue of involving selling an uncovered put below the expected range. As such, traders should be keenly aware of the potential downside risk inherent in the strategy and take steps to manage it.