- Sell an OTM put
- Sell vertical OTM call distribution.
This works best when volatility is high. Therefore, the selection of the best possible underlying asset for the implementation of the strategy is of crucial importance. The maximum profit is achieved if the underlying price is between the short strikes at expiration. The break-even price is the same:
Strike from Short Put – Loan Received
If a trader is extremely optimistic about the underlying asset, especially if it was recently sold, short puts or covered calls could be more profitable and appropriate. As with all strategies, timing and awareness of the interaction between a combination of options and the underlying price movement matter.
Options traders are always faced with the dilemma of when to close a position. Closing too early can result in lost profits and closing too late can result in a loss. The Jade Lizard can be closed by buying it to establish a net charge that is lower than the original balance created by the position. Traders may want to set a goal. For example, offsetting 50% of the original loan is an attractive return if that can be achieved. This is not unrealistic under very volatile conditions and just before it expires.
As the underlying asset moves through the short call spread, traders can roll the short put to add credit. However, this is not necessary as there is no upside risk due to the equalization within the spread (compared to the credit received). This approach – roll forward – is a popular approach for any trader working with short positions, either calls or puts. However, it can involve risks that are not readily apparent. For example, it ties up capital and collateral, often with little overall benefit. In some cases, a rollback can cause a reduced profit or even a loss if the rolling also includes a change in the strike.
If the short put is rolled forward, the trader should ensure that the added balance is worth the delay in the expiry. When the underlying asset is sold out and begins testing the short put, the short call spread can be reduced to get more credit without any upside risk. However, this multiple rolling activity delays the process and may not add significantly to the potential profit, which is limited before rolling begins. It might just make more sense to accept the outcome with no upside risk and avoid complex rolling strategies. Risks shouldn’t be ignored. These easily overlooked risks include the potential to lose by closing the entire position if the short put loss becomes too large.
The jade lizard isn’t the only imaginatively named strategy. If it is set up the other way around, it says a twisted sister. This is a combined vertical put spread for bulls plus a short call. The spread is determined by selling a put on a strike and buying another put on a lower strike. and then selling an OTM call on a strike over the put of the put strikes.
A disadvantage for the twisted sister can be seen in comparison to the jade lizard. The jade lizard relies on higher net credit than the twisted sister in using the same strokes. And the twisted sister’s uncovered call carries an unlimited upside risk. This is less desirable, of course, as traders are likely to prefer zero risk with the jade lizard over unlimited risk with the twisted sister. And possible losses in the loading lizard are limited to the distance of propagation compared to the large loss potential in the twisted sister.
Another comparison is between the jade lizard and the big lizard Strategies. The big lizard involves selling an ATM put and a call spread, hitting the short positions at the same time. This creates the greatest credit possible and is more like a straddle than a strangle like the jade lizard. However, traders are wise to compare risks and analyze the maximum profit potential versus the use of collateral and time invested. It is all too easy to be drawn to exotic positions but to overlook the realistic limiting factors.
Any strategy that offers limited maximum profit is worth careful study. The most popular example in this case is the covered call. Many covered call traders fail to realize that maximum profit is always limited to the premium received. and it is possible to lose money on the underlying asset when exercising, which more than offsets the profit on the short call. The sales restrictions deserve investigation for the jade lizard and twisted sister. If eliminating risk is attractive and a trader is willing to accept limited profits in return, these strategies might make sense. However, if the plan is to build wealth as soon as possible, then hedging strategies are unlikely to achieve that goal.
Another limiting factor is the time it takes to monitor positions and determine the best time to close positions in order to take profits (or limit losses). It might turn out that the time taken by many option strategies is not worth relatively small gains. This is one of the consequences of being drawn to exotic named strategies without thinking about the bigger picture. Nobody wants to spend a lot of time monitoring open positions just to make a few dollars in profit or to break even or make a small loss.
A wide range of strategies are worth being aware of, including the jade lizard and twisted sister. However, they should be subjected to realistic analysis before entering a position and before selecting strikes and expiration times.
Michael C. Thomsett is a widely published author with over 80 business and investment books, including the best-selling Get started with options coming in its 10th edition later this year. He also wrote the recently published The math of options. Thomsett is a frequent speaker at trade shows and blogs, as well as on Seeking Alpha, LinkedIn, Twitter, and Facebook.