Reverse Jade Lizard
The Reverse Jade Lizard option is a premium selling strategy with a neutral to bearish assumption.
What is the Reverse Jade Lizard?
The Reverse Jade Lizard option strategy is quite similar to the Big Lizard option strategy with the exception of no downside risk.
This strategy consists of a combination of an Out of the Money short call and an out of the money bull put spread so that, when developed correctly, it can eliminate any downside risk. You can read more about spread calculators here and our guide to out of the money or otm calls here.
That is the Reverse Jade Lizard option strategy involves selling Out of the Money call, and Out of the Money put and hedging the downside risk by purchasing a put of the same expiration but a different strike price.
The Reverse Jade Lizard option strategy is generally suited to advanced traders as it requires constant management.
Since this is a credit strategy, it is always safer to use it on stocks that are generally well bought in the market and have high implied volatility. The activity of these stocks should be within a range which makes it easier for traders to predict the market.
What is Jade Lizard?
Let's first look at a Jade Lizard which is a bull put credit spread with a combination of a put short and a short call spread. Unlike the Reverse Jade Lizard, it has no upside risk due to the collection of credit greater than the width of the short call spread.
A trader benefits from this strategy by using options with the exact expiration dates but different strike prices, resulting in collecting credit due to the movement of the stock's intrinsic value without concerning themselves regarding the direction or magnitude of the said movement.
However, there is a great risk factor involved with the Jade Lizard due to the fact that it lowers the breakeven points in both direction resulting in a higher chance of facing loses. The upside is that the risk is limited at the start – making it relatively safer.
How to set up the Reverse Jade Lizard option strategy?
The first step will always be finding a predictable stock whose activity is in a range. Since the Reverse Jade Lizard option strategy is a credit strategy, choosing a stock with range-bound action is very crucial to minimize the upside risks.
As mentioned before, the stock needs to have high implied volatility, somewhere around 90. This number suggests the percentage of time the stock was traded below the current implied volatility in the last year. This increases the chances of the implied volatility dropping soon, which will ensure a better credit spread.
The image below shows a number of options on tastyworks,
Opting for a stock closer to a 45 day expiration period is considerably safer and risk free. With the options present, it is wise to pick one that is closest to 45 days to 65 days expiry.
After choosing the best option, you need to be alert and focus on each move you make since everything you do from this point on will determine the profitability of your trade.
- Start by selling a short at the money straddle, as demonstrated in the picture above.
- After this, you need to buy an Out of the Money put from the credit received from the short. This will result in you gaining credit greater than the width of the put spread and will eliminate the risk of the downside.
As the image above shows, in this example, there is the put spread width of $10, while the total credit collected is $11.77, resulting in a profit of $1.77.
If you're looking to maximize your profits further, you can take this to the next step by using the $1.77 you have to buy a call which will effectively drop the buying power and will still leave you with a credit amount greater than the width of your put spread.
With the Reverse Jade Lizard, your profit target should be 10-20% of maximum profit which is possible with the methods we've discussed.
Management of Reverse Jade Lizard
The Reverse Jade Lizard option strategy can be profitable for traders; however, it comes with a number of risks attached. If your stock rallies and tests your breakeven analysis, it is vital for you to understand your options.
In the situation where the risk is more significant than $500, and there are 21 days left till expiration, you should close the trade and reestablish a new trade with your initial mechanics in the next cycle.
However, in the scenario where the risk is less than $500, you have the option of leaving it beyond 21 days and letting it play out till expiration, expecting to be able to close the trade for a small win.
When the Reverse Jade Lizard option strategy is done correctly the total credit received is greater than the width of the put spread resulting in zero risk to the downside.
For advanced traders, the Reverse Jade Lizard is a strategy that will significantly increase their profitability from their trades; however, for novice traders, the risk is far too big.
On the other hand, while the risk involved in Jade Lizard is limited and capped at entry, this strategy is all the riskier due to its ability to reduce your breakeven points in both directions. As a result, the risk of incurring losses is maximized.
That said, many stock traders use both Jade Lizard and Reverse Jade Lizard to make money and increase their profitability. The bottom line is that regardless of whichever trade option you prefer, you should only use it if you are comfortable with the risk window and have comprehensive knowledge of how it functions and how to set it up correctly.
You might be also interested in Poor Man’s Covered Call.