Jade lizard variation

Graybox Trading

Apr 06

I wanted to share a very interesting Jade Lizard options variation that may be useful for directional traders and provide added edge.

The Setup

The strategy involves selling a put below the market, buying a call at the market, and selling a call above the market.

What this allows the trader to do is create a payoff scenario where one can make several times as much on a one standard deviation move in your favor compared to a one standard deviation move against you. Likewise, you make way more on a two standard deviation move in your favor then you lose on a two standard deviation move against you. You would sell an OTM call around two standard deviations and sell an OTM put around minus two standard deviations for the bullish case.

Importantly, your undefined risk is only on one side of the trade, the side if the market goes down.

Let’s recap the benefit is that again if you bet wrong on direction for up to two standard deviations against you then you stand to lose 1R or less. Depending on the strikes, you might lose or make a little if the market doesn’t move.

However, if you bet right you can make many times your loss. The catch is that you have at at least one naked position on, such as a short put if you are long biased.

But wait, in order to make it risk defined, you can buy a deeper OTM put. The trade would thus have defined risk on both sides. You are essentially then long a put spread and long a call spread.

I would need to do at least three things before I would consider to trade the undefined risk version of a strategy like this. I would need to model and understand how the P&L of the strategy could change as the options pricing changes, stress test it over several years, and have a clear plan how to limit my risk in event of a multiple standard deviation move. The risk defined version looks like something I might be able to use, however.

Let me know if you have tried this strategy or one like it and how it works for you and how you manage the risk. If you trade naked options on futures, let me know also how that works for you.

About the Author

The author is passionate about markets. He has developed top ranked futures strategies. His core focus is (1) applying machine learning and developing systematic strategies, and (2) solving the toughest problems of discretionary trading by applying quantitative tools, machine learning, and performance discipline. You can contact the author at curtis@beyondbacktesting.com.