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TL;DR

“Good-To-Know’s”

Pin Risk leads to complications for both option sellers and buyers. For sellers, if an option expires exactly at the strike price, the decision of assignment is left to the discretion of the option holder, which can lead to unexpected stock positions on the following trading day. For buyers, this uncertainty may lead to last-minute decisions on whether to exercise or let the option expire.

Additionally, market makers and large traders may attempt to "pin" the stock to a certain level, influencing price movement near expiration. Traders managing positions with significant exposure to pin risk often close their trades before expiration to avoid unwanted assignments or unplanned stock positions.

Relevant Quote(s) I Like

Thought Throttle

The Cash Secured Put (CSP) is one of the foundational strategies in options trading, especially for those who specialize in strategic options selling. It's beloved for its simplicity and flexibility, allowing traders a level of indifference in the underlying assets rise or fall—so long as there isn’t a catastrophic market crash.

Essentially, a CSP is a way to generate income by selling put options while setting aside the necessary cash to buy the underlying stock if the price drops to the strike price. Here is a link to one of our previous articles about cash-secured puts if you are interested.

And while the CSP is powerful on its own, savvy traders can add layers to it, enhancing its potential returns. The key to maximizing a CSP’s profitability is to increase the premiums you collect, and there’s a strategy specifically designed for that—enter the Jade Lizard.

Jade Lizards

A Jade Lizard is a more advanced setup that involves selling a CSP along with a bear call credit spread (Click here to review our article on credit spreads). This creates a position that involves three options in total: the put and two calls in the bear spread. The beauty of the Jade Lizard is that it allows you to collect premium on both sides of the position.

The strategy is so named because of the unique shape of the risk/reward profile when graphed, which resembles a lizard (See below). The Jade Lizard is especially attractive because it offers a profit potential even if the stock moves within a relatively wide range, and best of all, when covered, it doesn't leave you with any undefined risk, unlike some other options strategies. By stacking these layers, you can juice the premiums you collect, potentially making a lot more than a simple CSP would on its own.

Jade Lizards vs Cash Secured Puts

Reverse Jade Lizards

Once the CSP is assigned, we can then transition into a Reverse Jade Lizard. This is the Covered Call version of the Jade Lizard. It involves selling a covered call along with a bull put credit spread.

Like the Jade Lizard, the Reverse Jade Lizard also involves three options in total: the call and two puts in the bull spread. Similarly, the beauty of the Reverse Jade Lizard is that it allows you to collect premiums from both sides of the position, generating income regardless of which direction the stock moves (within certain bounds).

The Reverse Jade Lizard is appealing because it provides profit potential even if the stock moves within a fairly wide range—though, of course, not to the extremes. By combining the bull put spread and covered call, you're able to increase the premiums collected, giving you the opportunity to generate more income than a simple covered call or put spread on its own (Risk profile below).

Reverse Jade Lizards vs Covered Calls

Important Details to Consider

It is important to note that both the Jade Lizard and Reverse Jade Lizard involve 3 options legs—meaning there's more to consider and manage than a single-leg. With more options in play, the chances of slippage rise.

Slippage happens when there is a discrepancy between the expected price and the actual execution price, often due to a wider bid-ask spread, so it’s crucial to trade options that have high liquidity and tight spreads. Always ensure that the underlying asset you’re using for these trades has substantial volume and open interest to narrow the bid-ask spread and minimize the impact of slippage on your overall returns.

Additionally, while the Jade Lizard and Reverse Jade Lizard are effective strategies for increasing premiums, they are not the only ones available. There are numerous other strategies that can help enhance the premiums received, but many of these come with added risks, such as selling naked options or tying up more capital.

The Jade Lizard family of strategies stands out because it offers a straightforward approach to collecting premiums without exposing yourself to undefined risk or requiring large amounts of at-risk capital, making it a relatively conservative yet profitable choice for strategic traders.

Case Study

Here is an example of a trade that took place back in the fall of 2024. Let’s go back:

It is August 1st, 2024, and we are bullish on Nvidia. It currently sits at $117.02. To begin, a 16 AUG 2024 CSP with a strike of $111 is sold. This option has a delta of ~30, and we receive a premium of $257. We then sell the bear call spread. This consists of selling a 16 AUG 2024 Call with a strike of $127 (~25 delta, $180 premium received), and buying a 16 AUG 2024 Call with a strike of $130 ($131 premium paid). The total net premium received for the CSP and Spread is $306.

August 16th comes, and Nvidia sits at $122.86. The CSP expires OTM, along with all of the calls expiring OTM. We get to keep all of the premium.

We turn around and enter the same setup again, but with an expiration of 6 SEPT 2024. This time we sell a CSP with a strike of $115. This option has a delta of ~30, and we receive a premium of $385. We also sell another Bear Call Spread with a 6 SEPT 2024 expiration, consisting of selling a $139 strike call for $253, and buying a $142 call for $217. The total net premium received for the CSP and the spread is $421.

On September 6th, NVDA closes at $107.21, and our CSP is assigned. We buy 100 shares of NVDA for $115/share.

We then enter into a Covered Call on the recently purchased shares, along with selling a bull put spread for extra income. This is where the Jade Lizard becomes a Reverse Jade Lizard. We sell a 27 SEPT 2024 $116 strike covered call (~30 delta) for $247, along with selling a $99 Strike Put (~25 delta) for $241, and buying a $96 Strike Put for $176.

On September 27th, NVDA sits at $124.04. The covered call is assigned at $116 per share, and the bull put spread expires worthless, allowing us to keep the additional premium.

The returns are listed below. We can also compare this to the traditional wheel strategy.

As we can see, the extra premium received from the Jade Lizards strategy was enough to substantially boost our return from 8.60% to 9.90%. When annualized, this is 83.08%, compared to the traditional wheel at 69.60%, certainly a worthwhile difference.

Disclaimers and Considerations

This strategy, and options trading in general, come with inherent risks. While they can enhance premium collection and provide structured risk management, they are not always straightforward. Every trade comes with the potential for loss, and market conditions can shift in ways that impact expected outcomes. Past performance, such as the case study provided, does not guarantee future results.

Options are complex financial instruments that require a thorough understanding of their mechanics, risks, and potential tax implications. Traders should carefully assess their risk tolerance, financial objectives, and experience level before implementing any options strategies.

Additionally, liquidity, slippage, and bid-ask spreads can affect execution prices and overall profitability. Always ensure that the underlying asset has sufficient volume and open interest to support efficient trade execution.

Consult with a qualified financial professional before engaging in any options trades for guidance with your specific situation. Trading options involves the risk of losing capital, and it is essential to conduct independent research or seek guidance from a licensed advisor before making trading decisions.

Throttle Q&A

What are the Tax Implications?

The tax treatment of options strategies like the Jade Lizard and Reverse Jade Lizard depends on factors such as holding period, whether the options are cash-settled or assigned, and whether they are classified as Section 1256 contracts or equity options under IRS rules.

Short-Term vs. Long-Term Capital Gains

• Since these strategies involve selling options, the premiums collected are considered short-term capital gains (taxed as ordinary income) unless the underlying stock is held for more than a year after assignment.

• If assigned and stock is held beyond a year, gains or losses on the stock position may qualify for long-term capital gains rates (typically lower).

Section 1256 Contracts (Broad-Based Index Options Only)

• If trading index options, they may fall under Section 1256, meaning they receive 60/40 tax treatment:

  • 60% of gains taxed at long-term capital gains rate

  • 40% taxed at short-term capital gains rate

• This rule does not apply to equity options like individual stocks or ETFs.

Wash Sale Rule Considerations

• If a put option is assigned and the stock is sold at a loss, but a similar position is re-entered within 30 days, the IRS wash sale rule could disallow the loss.

Qualified Covered Calls & Tax Implications

• If a covered call (from a Reverse Jade Lizard) is deep in the money, the IRS may disqualify long-term capital gains treatment on the stock.

Can You Increase the Ratio of Spreads in a Jade Lizard?

Yes, you can adjust the ratio of spreads within a Jade Lizard structure to modify risk and reward, but it changes the strategy’s characteristics. Here are some considerations:

Double or Triple the Bear Call Spread

• Instead of a 1:1 CSP-to-bear call spread ratio, you could increase the number of call spreads sold (e.g., 1 CSP + 2 Bear Call Spreads).

• This increases premium income but also increases risk if the stock rises significantly.

Adjusting Strike Prices for Risk Management

• Widening the spread distance (e.g., selling a $130/$140 instead of $130/$135) collects more credit but increases potential risk.

• Narrowing the spread (e.g., selling a $130/$132) reduces premium but limits loss potential.

Reverse Jade Lizard Ratio Adjustments

• If assigned on the CSP, the Reverse Jade Lizard could have a higher ratio of bull put spreads to covered calls.

• Selling more bull put spreads than covered calls increases downside exposure but boosts premium intake.

How does slippage impact the execution of a Jade Lizard, and how can a trader mitigate it?

Slippage occurs when there is a wide bid-ask spread, leading to unfavorable fill prices. Since the Jade Lizard involves three legs, slippage can reduce the expected premium collected. To mitigate this:

• Trade highly liquid options with narrow bid-ask spreads.

• Use limit orders rather than market orders.

• Consider entering each leg separately if the full order is difficult to fill.

What factors should traders consider when selecting strikes for a Jade Lizard?

Traders should consider:

• Delta: A lower delta for the put reduces assignment risk, while a higher delta call spread increases premium but caps upside sooner.

• Support and Resistance: Aligning strike prices with technical support/resistance levels improves the probability of profit.

• IV Rank: Entering when IV is high leads to better premiums, while low IV conditions may make the premiums less attractive. Though, lower IV will make it more likely that the underlying stays between your strikes.

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Disclaimer

The information provided in this newsletter is sourced from reliable channels; however, we cannot guarantee its accuracy. The opinions expressed in this newsletter are solely those of the editorial team, contributors, or third-party sources and may change without prior notice. These views do not necessarily reflect those of the firm as a whole. The content may become outdated, and there is no obligation to update it.

This newsletter is for informational purposes only and does not constitute personal investment advice. It is not intended to address your specific financial situation and should not be construed as legal, tax, or accounting advice, or as a recommendation to buy, sell, or hold any securities. No recommendation is made regarding the suitability of any investment for a particular individual or group. Past performance is not indicative of future results.

We strongly advise you to consult with a financial advisor before making any investment decisions, including determining whether any proposed investment aligns with your personal financial needs.