Today is LIZ’s birthday, and in honor of her birthday we are presenting a study on Jade Lizards. Jade Lizards take advantage of Volatility Skew. There are two ways to look at a Jade Lizard. You can see it as a short Strangle Combined with a long out-of-the-money (OTM) Call for protection or a short Put combined with a short Vertical Call Spread. Either way, the credit received should equal or exceed the width of the call spread. Our question is, which is superior, a 1 point wide spread or a 2 point wide spread?
Tom explained, “Here is how it works. Call Spreads trade expensive because out-of-the-money (OTM) Calls trade cheap. Put spreads trade cheap because OTM Puts trade expensive. This strategy takes advantage of a short Put which is expensive and a short Call Spread which is expensive. If you throw in high Implied Volatility into the mix you end up selling higher premiums.
Our study was conducted in the SPY (S&P 500 ETF) using data from 2005 to the present. We chose the option expiration cycle closest to 45 Days To Expiration (DTE). We compared a 1 point Jade Lizard comprised of a short Put for a 0.70 credit and a 1 point wide short Call Spread for 0.30 credit versus a 2 Point wide Jade Lizard comprised of a short Put for a 1.50 credit and a 2 point wide short Call Spread for 0.50 credit. The individual credits were approximate but the total credit received had to be at least the width of the Call Spread so there is no upside risk to the trade. Both trades were managed at 50% of max profit (if possible) or held to expiration.
Two P/L graphs of both strategies were displayed. The 1 point wide Jade Lizard had a higher Probability Of Profit (POP) but a lower profit potential and the 2 point wide Jade Lizard had a lower POP and a higher profit potential. A table showed that the average distance of the short Put from the underlying on the 1 point Jade Lizard was double of that of the short Put from the 2 point wide Jade Lizard. The short Call Spreads were relatively close to each other.
For more information on Jade Lizards see:
Market Measures from March 7, 2016: "Jade Lizard - Part 1"
Market Measures from March 9, 2016: "Jade Lizard: Part 2"
Options Jive from May 23, 2016: "Modified Jade Lizards'
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results of our study on whether 1 point wide Jade Lizards are superior to 2 point wide Jade Lizards.
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