The Jade Lizard is an options trading strategy that is designed to collect premium while maintaining a directional bias and eliminating the risk on one side of the trade. It’s typically used when the trader has a neutral to slightly bullish outlook on the underlying stock or index. The strategy combines a short put, a short call, and a long call option with a higher strike price. The idea is to generate a net credit that is the sum of the premiums collected from the short options, which should be greater than the cost of the long call.
Here’s how a Jade Lizard strategy can be structured using the NIFTY index as an example, with assumption that spot price of Nifty is now at 21729.8
- Sell a OTM Put Option: Choose a put option with a strike price below the current NIFTY level (21729.8 in this example). The put option should be out of the money (OTM). For instance, you might sell a NIFTY put option with a strike price of 21300.
- Sell a Near OTM Call Option: Then, sell a call option with a strike price above the current NIFTY level. This call option should also be out of the money. For example, you could sell a NIFTY call option with a strike price of 22000.
- Buy a Far OTM Call Option: Finally, buy a call option with a strike price higher than the call option sold. This option acts as protection in case the market rallies strongly. You might buy a NIFTY call option with a strike price of 22150.
When setting up the Jade Lizard, the premium received from selling the put and call should be greater than the premium paid for the higher strike call. The goal is to ensure the total credit received covers the difference between the strike price of the short call and the long call, effectively eliminating the upside risk.
Here is the Constructed Jade Lizard Strategy
- Sell 1x NIFTY 29th February 2024 22000 CE (Call) for a credit of ₹174.1
- Sell 1x NIFTY 29th February 2024 21300 PE (Put) for a credit of ₹98.6
- Buy 1x NIFTY 29th February 2024 22150 CE (Call) for a debit of ₹119.1
The net credit received from this trade setup is the sum of the credits from the short put and call (₹174.1 + ₹98.6 = ₹272.7) minus the cost of the long call (₹119.1), which equals ₹153.6.
Risk Profile:
- Maximum Profit: The maximum profit is limited to the net premium collected if the NIFTY closes above the put strike price and below the call strike price at expiration.
- Maximum Loss: The risk is limited on the upside because the loss on the short call is covered by the long call. However, if NIFTY falls below the put strike price, the strategy faces downside risk equal to the strike price of the short put minus the net premium received.
- Breakeven: The breakeven point for the put side of the trade is the strike price of the short put minus the net premium received.
Considerations:
- The strategy benefits from time decay (theta) since the options sold are out of the money.
- Implied volatility (vega) can impact the strategy; a decrease in volatility is beneficial since it will reduce the value of the short options.
- The strategy requires margin since it involves writing uncovered options.
In the example, the NIFTY is at 21729.8, and the strategy has a probability of profit of 80.38% with a maximum profit of ₹7,680 (6.00% return on margin/premium) and a maximum loss that is undefined due to the nature of writing a naked put. The breakeven point is calculated at 21147.0.
Remember, this strategy should be employed by those with a firm understanding of options trading and the risks involved. It’s important to manage the trade actively and have a plan for different market scenarios. Always be mindful of transaction costs and slippage, which can impact the overall profitability of the strategy.
Who Should Practice It?
The Jade Lizard strategy is ideal for intermediate to advanced traders due to several reasons:
- It involves writing uncovered options, which comes with margin requirements and the need for a thorough understanding of potential obligations.
- The strategy requires an understanding of how to manage the trade, particularly if the market moves against the position.
- Traders need to be able to select appropriate strike prices and expiration dates to ensure a favorable premium collection while managing risk.
- Since it involves a combination of options, traders should be comfortable with complex strategies and the potential adjustments that might be necessary during the life of the trade.
