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I receive an overwhelming amount of emails asking about how to invest in bitcoin, cryptocurrencies and the like. Unfortunately, as a quant-based trader/investor, I always want probabilities on my side, so buying into one of the thousand or so cryptos just isn’t my style.
However, we are starting to see some liquid products with options move into the crypto market and that is something that draws my attention. But before I get to an example of a potential trade, I also want to discuss the strategy I will be using.
Back in mid-July I mentioned a strategy unfamiliar to many options traders and investors…the jade lizard.
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 in slightly lower markets as well.
This trade works best on lower-priced stocks (less than $60) that have a high implied volatility.
The trade set-up 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)
For example, if the strikes of your bear call spread are $2 wide, we would want to collect at least $2 in premium from our short put and bear call spread. Any premium less than the width of our chosen bear call spread and the jade lizard strategy will not be as effective.
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 a neutral to bullish strategy, so that should be our leaning going into the trade.
The first item is to look for an underlying stock that has a high implied volatility (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, I found a decent candidate, Amplify Blockchain ETF (BLOK). 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 October 15, 2021 expiration cycle with 30 days until expiration. As you can see from the vertical bar highlighted in a peach color, the expected range or move is from roughly 44.50 to 53.00.
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 1-strike-wide bear call spread, so we need to look for a put that totals roughly 70% of the $1.00, or roughly $0.70.
So, taking that into account, let’s choose the 45 put strike selling for roughly $0.85.
Again, we can bring in roughly $0.85, which covers 85% of our 1-strike-wide bear call spread.
In this example, the probability of success on the downside is 72.36%. My preference is to be above 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 $0.85 worth of premium from selling the 45 put, we can look towards the bear call spread to bring in the remaining premium, or $0.15, if not more. Again, this will meet our requirement of bringing in enough premium to cover our 1-strike-wide bear call spread.
If we look at the 52/53 bear call spread, we can bring in roughly $0.25 worth of premium. Our probability of success on the upside is 72.24%, but remember, in total, between selling the put and bear call spread we are able to bring in $1.10 ($0.85 + $0.25). So, our upside has no risk, whatsoever. BLOK can move $10 higher, and we will not experience any upside risk.
Best case scenario is if BLOK closes at expiration between the 45 put strike and 52 calls strike. If so, we would receive a max profit on the trade. However, in most cases, I will take off the trade when I can lock in 50% to 75% of the original premium sold.
How to Manage Risk When Using a Jade Lizard Options Strategy
If BLOK does move higher and through our bear call spread, even though we have no 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 BLOK pushes lower, we can roll down the bear call spread to bring in more premium.
Worst case, scenario is that we can allow ourselves to be put BLOK shares, in this case for 45, or simply close out the trade. Just remember, we have brought in $1.10 worth of premium, so our downside risk is 43.90 (45 put strike – $1.10 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 trade example that would be $0.55 to $0.30
Trade Summary for Amplify Blockchain ETF (BLOK)
Directional Assumption is neutral to bullish.
- Trade Setup: Sell OTM put
Sell OTM bear call spread (short call vertical)
- Trade: Sell to open 45 put for $0.85
Sell to open 52/53 bear call spread for $0.25
Total credit or premium = $1.10
- Max Profit: Credit received from trade or $110. Max profit occurs when the stock, in this case BLOK, closes between the short put strike and short call strike at options expiration.
- Breakeven: strike price of short put – premium or credit received (45 – $1.10) = 43.90
- No risk to the upside.
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 feel free to email me.