Understanding the Jade Lizard Options Trading Strategy

Most retail traders who engage in stock options trading may only be aware of a few basic options trading strategies like the covered call, long call, straddle or strangle. If you too are familiar only with a few such strategies, Options B.R.O. from Samco Securities can help you find advanced options trading techniques to suit different market conditions and outlooks. With this advanced strategy builder, you can also execute your strategies directly from the Samco trading app with just one click.

One such advanced strategy is the options jade lizard. If the Samco options strategy builder recommends this strategy, you need to be aware of what it is and how it works, so you can decide whether it is a suitable technique for your trade. This article can help you understand the jade lizard strategy in detail.

An Overview of the Jade Lizard Strategy

The jade lizard is a three-legged options trading strategy that brings together a short put, a short call and a long call. With two short positions stacked against one long trade, this strategy aims to open at a net credit, so you can collect premiums at the outset instead of starting with a net debit.

Despite being relatively lesser known among beginners, the jade lizard strategy is fairly easy to set up and use. Its use case and expectations are also quite uncomplicated. The strategy gets its name from the way its profit and loss profile appears on the graph. More specifically, the profit region or the green zone resembles a lizard, which is why the strategy is labelled the jade lizard.

When to Use the Jade Lizard Trading Strategy

Different options trading strategies work for different market conditions. No strategy ever works for all markets. This is why it is crucial to align your choice of trade with your market view. Samco’s Options B.R.O makes this easy for you because you do not need to research and filter through 1000s of strategies manually. Instead, by simply submitting your market outlook along with a few other details, you can get the top strategy recommendations for that market movement.

Options B.R.O. may suggest the jade lizard strategy if you have a neutral to slightly bullish outlook. The usage of a short call (which is a bearish trade) against a short put and a long call (which are both bullish trades) means that this strategy has a slightly bullish directional bias. So, it is best used if you expect the underlying asset’s price to rise slightly, but not significantly, by the expiry date.

Setting up the Options Jade Lizard Trade

To set up the jade lizard option trade, you need to combine three positions — a short put, a short call and a long put. Let us get into the details of this trade setup.

• Trade 1: Write an OTM Put Option

This is the short put. The strike price of this put option should be below the asset’s market price. You will earn a premium on this trade.

• Trade 2: Write a Near OTM Call Option

This is the short call. The strike price of this call option should be above the asset’s current market price. Here too, you earn a premium because you sell an option contract.

• Trade 3: Purchase a Far OTM Call Option

This is the long call. The strike price of this call option should be higher than the short call’s strike price. You will have to pay a premium for this option. However, since this is a further OTM call, the premium will be lower than the short call’s premium. This will result in a net credit for your jade lizard position overall.

Key Price Points in a Jade Lizard Strategy

To better understand this three-legged options trading strategy, you need to have more clarity about its risk profile. This includes knowing when the strategy’s risk is maximised, when its profit is the highest and when it could break even. Check out these details below:

• Highest Profit:

The net credit earned at the outset is the maximum profit you can get from this trade. The profit is maximised if the asset’s price at expiry is between the strike prices of the short trades. This is because all three options expire worthless, leaving you with the net premium collected.

• Maximum Loss:

The loss on the upside is limited in this options trading strategy because the risk of one of the call options is covered by the other call option (since you have opposing positions in the calls). That said, if the asset’s price at expiry is significantly less than the short put’s strike price, your risk is maximised. The lower the asset’s price, the more the risk.

The loss can be calculated using the formula shown below:

Loss = Short Put Strike Price — Asset Price at Expiry — Net Premium Received

• Break-Even Point:

This is the price point at which the jade lizard option trade leads to a ‘no profit and no loss’ outcome. In other words, the gains equal the losses at this point. On the upside, this strategy poses no risk when you set it up correctly. So, the concept of a break-even price is only valid on the downside or on the side of the put’s strike price. Mathematically, this point can be quantified using the following formula:

Downside Break-Even Point = Short Put Option’s Strike Price — Net Premium Credit

Possible Outcomes of this Options Trading Strategy

Now that you have seen how to set up the options jade lizard trade and what its key price points are, you may be in a better position to appreciate when and to use this strategy. Let us discuss a hypothetical example to give you more clarity about the possible outcomes of this trade.

Say a company is currently trading at Rs. 700 per share. You expect its price to rise slightly by the near-month expiry and you require some income upfront. So, you decide to set up a jade lizard options trade and initiate the following positions:

• Trade 1: Short Put

Here, you sell one lot of OTM put options with a strike price of Rs. 690 and earn a premium of Rs. 8 per share.

• Trade 2: Short Call

Here, you sell one lot of OTM call options with a strike price of Rs. 710 and earn a premium of Rs. 13 per share.

• Trade 3: Long Call

Here, you purchase one lot of far OTM call options with a strike price of Rs. 720 and pay a premium of Rs. 9 per share.

So, the net credit at the outset is Rs. 12 per share (i.e. Rs. 8 + Rs. 13 — Rs. 9). If the lot size is 100, the net opening credit becomes Rs. 1,200. Now, let us analyse the different possible outcomes, where the share price either rises or falls at expiry.

• Scenario 1: The Stock Price Increases Slightly at Expiry

Say the market is slightly bullish as you expected and the stock price rises from Rs. 700 at the time of the trade setup to Rs. 705 at expiry. In this case, here is what happens to each of the three options:

• Short put with Rs. 690 strike: Expires worthless

• Short call with Rs. 710 strike: Expires worthless

• Long call with Rs. 720 strike: Expires worthless

This leaves you with the maximum profit from the trade, which is the net premium received i.e. Rs. 1,200 (adjusted for any margins and costs of trade).

• Scenario 2: The Stock Price Increases Significantly at Expiry

You expected the market to be slightly bullish. However, what happens if the stock price increases significantly rather than slightly? Say at expiry, the stock price is Rs. 730. In this case, here is how each of the three options trades will pan out:

• Short put with Rs. 690 strike: Expires worthless

• Short call with Rs. 710 strike: Results in a loss of Rs. 20 (i.e. Rs. 730 — Rs. 710) per share, leading to a total loss of Rs. 2,000 (i.e. Rs. 20 x 100 shares)

• Long call with Rs. 720 strike: Results in a profit of Rs. 10 (i.e. Rs. 730 — Rs. 720) per share, leading to a total gain of Rs. 1,000 (i.e. Rs. 10 x 100 shares)

So, the net result from the trade, after adjusting for the upfront premium credit, is a profit of Rs. 200 (i.e. Rs. 1,200 + Rs. 1,000 — Rs. 2,000). While this is nowhere near the maximum profit possible from the jade lizard, it is, nevertheless, not a loss.

• Scenario 3: The Stock Price Falls Below the Short Put at Expiry

Now, let us assume the market moves in an entirely unexpected manner and turns steeply bearish instead of mildly bullish. If the stock price at expiry falls below the short put’s strike, say to Rs. 650, here is what happens to each of the three trades in the jade lizard:

• Short put with Rs. 690 strike: Results in a loss of Rs. 40 (i.e. Rs. 690 — Rs. 650) per share, leading to a total loss of Rs. 4,000 (i.e. Rs. 40 x 100 shares)

• Short call with Rs. 710 strike: Expires worthless

• Long call with Rs. 720 strike: Expires worthless

So, the total loss from the position is the loss from the short put, adjusted for the net premium received. This results in a net loss of Rs. 2,800 (i.e. Rs. 4,000 — Rs. 1,200).

Advantages and Disadvantages of the Jade Lizard

The jade lizard strategy has both benefits and limitations. To make the most of this strategy, you need to know its strengths. To avoid its risk, you need to know its downsides. So, let us explore the two sides of this options trading technique in more detail.

• Benefits of the Jade Lizard

This options trading strategy can be advantageous to traders because of the following reasons:

• Upfront Income: This strategy gives you immediate income from the net premium received by selling two options and purchasing one instead. So, you can generate cash flow upfront.

• Benefits from High Implied Volatility: High implied volatility at the time of setting up the trade can increase the options premiums, so you can earn more from selling the call and put options.

• Useful in Neutral to Bullish Markets: The jade lizard is ideal when you are expecting a slight price increase. It profits the most when the asset price rises slightly but remains between the strikes of the two short options.

• Inbuilt Hedging: The use of the long call in the third leg of this options trading strategy offers an inbuilt hedge against significant upward price movements. This limits the potential losses on the upside.

• Limitations of the Jade Lizard

The jade lizard also has some risks and downsides. They include the following:

• Limited Profit: Even if the underlying asset’s price moves favourably, the profit potential in this strategy is capped at the net premium received.

• Significant Downside Risk in a Bullish Market: If the market unexpectedly turns bearish and the stock price falls below the short put’s strike, the losses can be significant.

• Margin Money Requirements: Depending on the asset price and volatility, this strategy may require substantial margin deposits on the short positions.

Conclusion

The bottom line is that when used in the right conditions and when set up properly, the jade lizard options trading strategy has the potential to be reasonably profitable. To make sure that you use this strategy in suitable market phases, you can use Options B.R.O. from Samco Securities. In addition to suggesting the strategy only when your market view is neutral to slightly bullish, this advanced options strategy builder also allows you to analyse the strategy in-depth before executing it.