The market has pushed significantly higher over the past two weeks.
As a result, the SPDR S&P 500 ETF (SPY) has pushed into a short-term overbought state.
When I see this type of set-up occur, I typically use a bear call strategy. As many of you know, it’s often my bread-and-butter trade when the market seems a bit toppy. But the reason I like it so much is that I have no clue if the trend is going to continue higher or not, so I prefer to use a bear call spread because it gives me a nice margin of error.
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However, I want to present a slight alternative today. A jade lizard on SPY. By doing so I essentially limit my overall risk on the upside, oftentimes eliminating my upside risk altogether.
So, let’s take a look a potential trade to see what we can find and if we can indeed eliminate all upside risk, while bringing in a decent amount of premium.
A jade lizard consists of a short put and a short call vertical spread (bear call spread) with limited maximum profit potential, and no risk to the upside. The strategy has a neutral to bullish market assumption but can also make money on slightly lower markets as well.
The credit that is created is higher than the width of the bear call spread.
The trade setup for a jade lizard options strategy is as follows:
- Sell an out-of-the-money put
- Sell an out-of-the-money bear call spread (short call vertical spread)
However, the above doesn’t get into the necessary details. The key is to create a credit from the short put and bear call spread that is greater than the overall width of our bear call spread.
For this to occur, in most cases, my goal is to bring in roughly 70% of the overall credit from my short put, which means 30% of my credit must come from the bear call spread. Now, of course, the percentages are approximations, but remember, the goal is to bring in an overall credit that is greater than the strike width of our bear call spread. By doing so, we eliminate all risk to the upside.
Jade Lizard Strategy – Step-By-Step
Remember, this is neutral to bullish strategy, so that should be our leaning going into the trade.
The first item is to look for an underlying stock or ETF that has a high IV rank and IV percentile. Implied volatility (IV) is one of the key components to any options pricing model, so when IV is high, we have the opportunity to bring in more premium.
After doing a quick screen (I’ll show you how to set up a similar screen in a follow-up video) on stocks with a mid-to-high IV rank, SPY fits the bill. Just remember, we are simply going through the mechanics of a jade lizard, so if the trade doesn’t meet your expectations, no worries, at least you will know how to implement the trade when an opportunity arises.
The next step is to take a look at the expected move of the expiration cycles ranging from 30 to 60 days.
Below is the April 27, 2022, expiration cycle with 33 days until expiration. As you can see from the vertical bar highlighted in yellow, the expected range or move is from roughly 433 to 467.
Ideally, we want to place our jade lizard outside of the range. But, the most important aspect is to keep our probabilities as high as we can while making sure the amount of credit we bring in exceeds the width of our bear call spread.
Let’s start by taking a look at the put side of things.
I plan on going with a 5-strike-wide bear call spread, so we need to look for a put that totals roughly 70% of the $5.00, or roughly $3.50. Of course, we might not always meet 70%, and that’s okay, the goal is to minimize our risk to the upside. So, let’s see what we can find.
Taking that into account, we can choose the 425 puts, thereby eliminating all risk to the upside. However, the probabilities aren’t as high as I would prefer given the market volatility we are experiencing at the moment. So, I’m going to go with the 410 puts. We can sell the April 27, 2022, 410 puts for roughly $2.18.
Bringing in $2.18 covers approximately 44% of our 5-strike-wide bear call spread.
In this example, the probability of success on the downside is 86.47%. My preference is to be closer to one standard deviation out, or approximately 68%.
Quick note: If I’m not pleased with my probabilities, at any time I can move on to another potential trade, possibly looking for an underlying stock that has a higher implied volatility.
Now that we know we can bring in $2.18 worth of premium from selling the 410 put, we can look towards the bear call spread to bring in the remaining premium, or $2.82. Again, this will meet our requirement of bringing in enough premium to cover our 5-strike-wide bear call spread. But also realize, probabilities are the most important aspect of the trade, so if we don’t hit $2.82, that’s okay.
If we look at the 470/475 bear call spread, we can bring in roughly $0.70 worth of premium. Our probability of success on the upside is 85.78%, but remember, in total, between selling the put and bear call spread we are able to bring in $2.88 ($2.18 + $0.70). So, our upside has some risk ($2.12), but our probabilities of success on the upside portion of the trade stands at 85.78%.
Had we attempted to achieve a premium of $2.82 from the bear call portion of our jade lizard we would need to use an at-the-money bear call spread with a 50% probability of success and I don’t play that game. Of course, we could have raised our put a little to bring in more premium, thereby allowing us to go with a slightly higher bear call spread, but we still would not have achieved the probability of success I prefer. And again, it’s the probabilities that lead the way to each and every trade I place.
How to Manage Risk When Using a Jade Lizard Options Strategy
If SPY does move higher and through our bear call spread, even though we have risk to the upside, we can roll up our put strike and bring in additional premium, thereby giving us a greater return on the trade.
If SPY pushes lower, we can roll down the bear call spread to bring in more premium.
I manage winning trades by taking off the trade when I can take off 50% to 75% of the premium that I brought in. In our example that would be roughly $1.40 to $0.70.
Trade Summary for SPDR S&P 500 (SPY)
Directional Assumption is neutral.
- Trade Setup: Sell OTM put
Sell OTM bear call spread (short call vertical)
- Trade: Sell to open 410 put for $2.18
Sell to open 470/475 bear call spread for $0.70
Total credit or premium = $2.88
- Max Profit: Credit received from trade or $288 per jade lizard. Max profit occurs when the stock or ETF, in this case SPY, closes between the short put strike and short call strike at options expiration.
The jade lizard is a great alternative to an iron condor and is a worthwhile strategy to add to your options strategy toolbelt.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.