«

»

May
28

Anatomy of the Jade Lizard

The Jade Lizard Spread

 This is a bullish strategy that takes advantage of high volatility generated leading up to news and earnings announcements. A Jade Lizard [JL] is made up of an Out-of-the Money [OTM] naked put and an OTM call credit spread. Because the JL involves a naked put, this trade is taken only with stocks you are willing to own. If your put is assigned you will pay the put strike for the underlying. However, your cost will be the strike minus the total credit received.

This strategy is a blend on an Iron Condor with a Strangle. The Iron Condor is generally traded with a modest payoff combined with a high probability of success. The risk is limited. A Strangle has unlimited risk [= the price of the stock minus the credit]. In exchange, the payoff is much higher.

JL is a high probability trade. It pays the full sum of the credits whenever the price of the underlying ends up between the short strikes. The short strikes are chosen 15% to 25% above and below the price. The sum of the credits should exceed the width of the call spread. It’s a risk-free trade even if the price rises above the call spread. The break-even point is below the short put strike. The risk is considered unlimited below that point. This never happens because you are obligated to buy the stock at a price discounted by the credits received. [A covered-call can also be sold to generate additional credit.] The initial expiration is 20 to 50 days.

The length of the trade generally depends on what happens to the underlying’s price following the earnings announcement.

The most interesting feature of this spread is its protection against loss. Loss occurs when the price drops below the break-even point. The put is not protected when the price falls. As the price drops, the Call Spread decreases in value and we roll it to a lower strike. The effect of the roll is to increase the total credit. This, in turn, lowers the break-even point. Multiple rolls are possible. Each generates more credit and further reduces the possible loss due to the short put.

Here’s a Jade Lizard example for RIMM on 1/28/2013

Price                      $16.18

Expiration             March

Sell Put                 Strike 13                              Credit $0.75

Sell Call                 Strike 19

Buy Call                Strike 20                              Net Credit $0.35

Break Even           $11.90

Total Credit 1/28/2013     $1.10.

If at expiration 13 <= RIMM <= 19 the profit = $110; RIMM >= 20 the profit = $10.

Here’s a possible JL roll down of the Call Spread on 1/30/2013. Note how this roll down lowers the Break-Even point.

Price                      $13.78

Buy 19/20 Call Spread                      $0.085

Sell 18/19 Call Spread                      $0.12

Total Credit 1/30/2013 = $1.10 + $0.035 = $1.135

Break Even           $11.865

If at expiration 13 <= RIMM <= 18 the profit = $113.50; RIMM >= 19 the profit = $13.50.

 Comparison of Jade Lizard and Iron Condor

The Jade Lizard has, in this example, more than double Iron Condor’s [IC]  potential gain [= the credit] if the price ends up between the short strikes. Above the long call strike [=20] JL has a small profit. Above this price the IC has a loss almost equal to its potential gain. The IC Break-Even is higher than JL’s. JL has greater losses than IC for prices below the Equal Payoff point. This point corresponds to an approximately 30% drop in price. At any expiration price above the Equal Payoff point, JL has a higher return. This shows why lowering JL’s Break-Even point reduces the risk.

JL vs ICI found a two year test comparing JL to IC  starting January 2011 for AMZN. All trades were kept to expiration without rolling to protect against losses. The table below summarizes the results.

 

Jade Lizard

Iron Condor

Losing Trades

3

4

Return on Capital

$3,784

$1,992

Probability of Profit

92%

70%

Margin Requirements

$2,381

$378

 

We employ 2 forms of the Jade Lizard. One is as described above. The other is somewhat  directional  with a greater threat on one side compared to the other. We  can shift the risk.

;

 

 

 

 

 

 

3 comments

1 ping

  1. Allen says:

    Thanks so much the break down of this trade.Do you have any suggestions on how to find the best stocks to make this option trade and the criteria of how you go about to finding the stock?

    1. DrJay says:

      High volatility is the key. After all, this strategy is selling volatility. Often the day before earnings there is a volatility spike. A few days later the dust clears and you can buy back your trades for a fast short profit.

  2. JENIFER says:

    We have gone ahead and added a link back to your internet site from one of my clients requesting it. I’ve used your blog URL: and blog title: to guarantee you get the proper anchor text. If you woud like to check out where your hyperlink has been placed, please contact me at:. Thanks alot :)

  1. The Pairs Builder Plan » grabthecashanddash.com says:

    [...] The Jade Lizard allows you to allocate additional funds with another high probability trade. We plan to offer [...]

Leave a Reply

Your email address will not be published.

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>