The Life Cycle of a Jade Lizard

Key Concepts

• Jade Lizard Strategy: An options strategy combining a short put and a short call spread, designed to collect premium with limited or no upside risk.
• Short Put: Selling a put option, profiting if the underlying stock stays above the strike price.
• Short Call Spread (Bear Call Spread): Selling a call option and buying a higher-strike call option, used to profit from a stock staying below a certain level, with defined risk.
• Naked Premium: Selling options without owning the underlying asset, aiming to profit from time decay and implied volatility.
• Extrinsic Value: The portion of an option's premium that is not intrinsic value, representing time value and implied volatility. It decays over time.
• Delta: A measure of an option's price sensitivity to changes in the underlying asset's price. A 30 delta put means the option's price is expected to move $0.30 for every $1 move in the underlying.
• Implied Volatility (IV): The market's forecast of a likely movement in a security's price. IV contraction means implied volatility has decreased, which benefits option sellers.
• Bid-Ask Spread: The difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). Wider spreads indicate less liquidity.
• Buying Power: The amount of capital available in a trading account to open new positions.

Introduction to the Jade Lizard Strategy

The video introduces the "Life Cycle of a Trade" series, focusing on the thought process behind trade entry, management, and closing. This specific episode details the implementation and management of a Jade Lizard options strategy using UAL (United Airlines) as an example. The primary goal of a Jade Lizard is to sell a put and a call spread for enough credit to cover the upside risk of the call spread, effectively creating a position with no risk to the upside.

Initial Trade Setup: UAL Jade Lizard

The trade was initiated on UAL, which was trading at approximately $66 and change. The stock had experienced a significant move lower but had bounced back in recent weeks, still remaining near its recent lows (dating back to October/September of the previous year). This presented an "interesting point to do some naked premium with a jade lizard."

Strategy Rationale and Components: The core idea is to collect sufficient premium from selling a put and a call spread such that the total credit received is equal to or greater than the width of the call spread. This ensures that even if the stock rallies significantly through the call spread, the collected premium covers the maximum potential loss from the call spread, resulting in no upside risk.

Specifics of the UAL Trade Setup:

1. Short Put Selection:

   • A 30 delta put was targeted, which corresponded to the $60 strike price.
   • The rationale for choosing a wider call spread was to allow for a faster-moving trade, as wider spreads tend to hold extrinsic value longer, benefiting from its decay.

2. Short Call Spread Selection:

   • Initially, a $5 wide call spread (e.g., 70/75) was considered, aiming to collect a small credit above the width.
   • However, the final selection was a $2.50 wide call spread using the 70/72.5 strikes.
   • The target credit for this call spread was about $1.00 (or at least 90 cents), which was achieved as it was trading around 90 cents.

3. Combined Jade Lizard Package:

   • The final trade involved selling the $60 put and selling the $70/$72.5 call spread.
   • This setup created a risk profile with no risk to the upside, meaning the maximum potential loss on the call spread was fully covered by the total credit collected.
   • The total credit collected for the entire package was $4.07 (initially aimed for $4.10, filled at $4.07).
   • The trade utilized approximately $800 in buying power.

Trade Management and Outcome

Stock Movement and Impact: After the trade was placed, UAL experienced a "very nice rally," moving from its entry price of approximately $66.25-$66.50 to $74 and change.

Performance of Options Components:

1. Short Call Spread (70/72.5):

   • Despite the stock moving significantly higher and into the call spread, the spread, which was $2.50 wide, was only trading at $1.50 at the time of management.
   • This demonstrates the principle that options spreads do not immediately trade at their full intrinsic value until expiration, retaining some extrinsic value. This meant the call spread "really didn't hurt us all that much."

2. Short Put (60 strike):

   • The $60 put, which was sold for $3.05, was now marked at $1.30.
   • This represented a profit of $1.70 from the put component alone, as the stock moved away from the put strike.

Implied Volatility (IV) Contraction: A significant factor contributing to the trade's success was a favorable implied volatility (IV) contraction.

• At entry, the IV index for UAL was approximately 64.7%.
• At the time of management, it had decreased to 60.6%, representing about 4 points of IV contraction.
• This decrease in implied volatility further reduced the value of the options sold, benefiting the seller.

Overall Profit and Exit: The combination of a correct directional assumption (UAL rallying) and a beneficial IV contraction led to a "really sizable profit in just a couple days" (approximately one week).

• The trade was showing a marked profit of $134 (based on a marked debit of $2.73 to close).
• The position was exited for a $2.75 debit, resulting in a net profit of $132 on the Jade Lizard.
• This profit represented approximately 20-25% of the maximum potential profit for the trade.

Challenges During Exit: The speaker noted that bid-ask spreads for in-the-money options (like the call spread) tend to widen out, making it slightly harder to get filled at mid-price. For example, the call spread had 15-20 cent wide spreads, whereas out-of-the-money puts had only 5 cent wide spreads. This required a slight adjustment to the exit price.

Conclusion

The UAL Jade Lizard trade was a successful example of combining a correct directional assumption with favorable market conditions, specifically a decrease in implied volatility. The strategy effectively managed upside risk by collecting sufficient premium to cover the call spread's width. The trade generated a quick and substantial profit of $132 (20-25% of max profit) within about a week, demonstrating the effectiveness of the Jade Lizard strategy when executed with proper risk management and market analysis.