Jade Lizard Options Strategy (Ultimate Guide)
The Jade Lizard is a neutral options strategy (with a slightly bullish bias) built by combining an OTM (out-of-the-money) short put and an OTM credit call spread.
The strategy has limited profit potential and a high downside risk. The Jade Lizard has no upside risk if the total premium collected from the sale of the naked put and the credit call spread is greater than the width of the call spread.
Ideally, the Jade Lizard options strategy is used in a high implied volatility (IV) environment. For example, it can be used successfully on oversold stocks with high implied volatility that are not expected to reverse sharply to the upside before expiration.
The Jade Lizard can be used on any underlying asset, such as stocks, ETFs, or indices. For simplicity, in this article I will be referring to stocks.
Jade Lizard Trade Setup
The Jade Lizard is a 3-leg options strategy, with all legs having the same expiration date.
- The first leg is a short put sold at the A strike price for a credit.
- The second leg is a short call sold at the B strike price for a credit.
- The third leg is a long call bought at the C strike price for a debit.
The relationship between the strikes is as follows:
- A is lower than B
- B is lower than C
When opening the position, the price of the underlying stock is higher than A, but lower than B and C.
The second and third legs combined together (B-C) form a (bear) call credit spread. The credit received by selling the short call of the spread is higher than the debit for opening the long call. So the call credit generates an overall net credit.
As previously mentioned, both the short put and the call credit spread are out-of-the-time (OTM) as the price of the stock at trade initiation is above the short put strike and below the short call strike.
Looking at the Jade Lizard setup from a different perspective, it can be seen as a Short Strangle with an upside protection, or an Iron Condor without a downside protection.
The combined trading orders you have to place on your broker platform to open a Jade Lizard position are as follows:
- Sell-to-Open an OTM short put (at the A strike) for a credit
- Sell-to-Open an OTM vertical call spread (at the B-C strikes) for a net credit
The combined trading orders you have to place on your broker platform to close a Jade Lizard position are as follows:
- Buy-to-Close the OTM short put (at the A strike) for a debit
- Buy-to-Close the OTM vertical call spread (at the B-C strikes) for a net debit
Jade Lizard Maximum Profit
The total credit received when opening the position determines the maximum profit of the Jade Lizard options strategy. So it's the sum of the premiums earned from the short put and the vertical call spread.
At expiration, the maximum profit on the Jade Lizard is realized when the stock price remains between the short put strike (A) and the short call strike (B).
Jade Lizard Maximum Risk
A Jade Lizard position has no upside risk when properly set up. To accomplish this, the total credit collected from selling the short put and the vertical call spread must be greater than the call spread's width.
On the downside, the short put strike minus the total credit received on the position represents the maximum risk. The maximum loss is recorded when the underlying stock price falls to zero before expiration.
Jade Lizard Trade Rationale
A Jade Lizard is used by a trader who believes a stock is neutral to bullish. However, because the position includes a bear call spread, the outlook should not be overly optimistic.
The trade is appropriate for stocks that have been oversold following a sharp pullback and have a high implied volatility rank (IVR). This condition typically generates a high premium due to the stock's volatility being above its average values.
The lack of upside risk is beneficial in the event that the underlying stock price rises sharply and moves above the call spread strikes.
Jade Lizard Trade Management
The Jade Lizard is closed for a profit when the entire position can be bought back for a net debit that is lower than the credit collected at the entry. This normally happens if the stock price stays between the short put and the short call spread during the life of the position.
Around 50% of the maximum profit could be considered as the first acceptable profit target level. That is half of the total credit received when entering into the position.
Of course, you might decide to take profit at a higher level and retain a bigger portion of the premium originally collected. This might allow a better rate of return, but also higher risk due to the extended trade duration. As always, in options trading, it is all about finding the optimal balance between risk and reward.
If the stock moves above the strikes of the vertical call spread before expiration, the short put can be rolled up to collect an additional premium. However, this adjustment can be avoided as a Jade Lizard trade properly structured doesn't carry any upside risk.
In case the underlying stock moves down testing the short put strike, the vertical call spread can be rolled down to generate additional premium still leaving the upside risk to zero. Of course, if the stock price moves sharply to the downside, you can close the entire position for a loss, before it becomes too big.
On the other hand, if the outlook on the stock is still bullish (and you have enough capital to buy the shares in case of assignment), you might consider rolling out the short put to a further expiration date for a net credit, and even opening a new vertical call spread to the same date.
This will allow you to collect more credit and reduce the downside risk on the position. If you get assigned the shares at the strike price, you could start selling covered calls against the shares to reduce their cost basis even more.
Of course, this management approach should be avoided if the long-term outlook for the stock (and the company behind the stock) becomes bearish. No repair strategy (other than buying puts or selling bear call spreads) is capable of handling a company that is going bankrupt.
Reverse Jade Lizard
The Reverse Jade Lizard is a slightly bearish strategy combining an OTM (out-of-the-money) short call and an OTM bull put credit spread. The strategy is best suited for overbought stocks with a high implied volatility rank.
The Reverse Jade Lizard options strategy has a limited profit and unlimited upside risk. If structured properly, this strategy has no downside risk.
Jade Lizard FAQ
Which is the Edge Behind the Jade Lizard Strategy?
The Jade Lizard options strategy seeks to capitalize on the volatility skew inherent in options. Short puts typically generate more premium than short calls, while short call spreads typically generate higher premiums than short put spreads.
This volatility skew effect allows a Jade Lizard trader to collect a higher premium for the overall position than a Reverse Jade Lizard trader. This increases the Jade Lizard's profit potential when compared to the Reverse Jade Lizard.
How is the Jade Lizard Different from an Iron Condor?
The Jade Lizard, like the Iron Condor, has a wide profit zone. The primary distinction between a Jade Lizard and an Iron Condor is that the short put provides no downside protection. This increases the strategy's profit potential, but it also exposes the position to a much higher risk if stock prices fall.
How Does a Change in Volatility Affect the Jade Lizard?
The Jade Lizard, like an Iron Condor, is a negative vega trade. Vega is the greek that describes a position's exposure to changes in implied volatility.
The Jade Lizard usually benefits from a decrease in implied volatility. If volatility rises after the trade is entered, it will almost certainly lose money.
Why Does the Jade Lizard Have this Name?
Liz Dierking and Jenny Andrews, former CBOE floor traders, coined the term "Jade Lizard" for this type of options trade setup on the Tastytrade Network's Liz & Jny Show.
Remember that the options are financial products that carry significant risk. If you have no trading experience, you should seek out professional investment advice before putting any money at risk. Each individual investor should evaluate his or her financial situation and investment objectives before selecting an investment strategy and getting involved in options or stock trading. Potential losses in option trading can exceed the invested capital.
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