Improving the wheel with Jade Lizards

The wheel is the strategy about which I receive the most questions, by far. The general pattern of the wheel is as follows:

1) Sell cash-covered (aka cash-secured) puts to collect premium until assigned.
2) Sell covered calls to collect premium until assigned.
3) Re-consolidate cash and return to selling cash-covered puts.

It is a simple strategy that most any broker will let you execute. However, there is a method of improving Step 1 by initiating the wheel with a Jade Lizard instead of a cash-secured put. This post will explore this method. Thank you to AverageJoey2020 and Crisp for bringing up this idea.

tl;dr Jade Lizards combine a cash-covered put with a call credit spread. Use a Jade Lizard instead of a cash-covered put to pull additional premium and improve your breakeven price. In exchange, you take the additional risk of making smaller amounts of money if the stock breaks your call credit spread's long strike (though you cannot suffer a loss due to the stock increasing in price when you establish a Jade Lizard correctly). This method is only effective when premiums are high enough to facilitate Jade Lizards, generally requiring a stock price of at least $25 and medium volatility.

Acronyms used:
JL: Jade Lizard
CCS: Call Credit Spread
CSP: Cash-Secured Put (same as a Cash-Covered Put)
c: call
p: put
AAPL: Apple Stock Ticker

What is a Jade Lizard?

I owe you all a video on Jade Lizards, but it may be months before I have the time to make one. 

Jade Lizards are a relatively exotic strategy that involves selling a put and opening a call credit spread at higher strike prices. If you have Level-4 options trading, you can set up a Jade Lizard without the short put being cash-secured. In the context of Theta Gang, anticipate making the short put cash-secured so as to initiate the wheel.

A properly established Jade Lizard will always be profitable to the upside. That is, despite a call credit spread causing max loss if the stock expires about your short call, the premium from the short put will more than offset that loss. 

Example of a correct Jade Lizard:
STO 1x AAPL $295c for $300
BTO 1x AAPL $300c for $150
STO 1x AAPL $290p for $360

You'll recognize the first two legs as a call credit spread. You are opening the spread for $150 credit and the max loss (difference between strikes minus premium) is $350.

The third leg is the cash-secured put. By selling the CSP for more than the max loss on the call credit spread, we guarantee that we maintain a profit if the stock rises right through our call credit spread.

If AAPL rises to $305, then we will suffer the max loss of $350 on the call credit spread, but we will realize the full $360 premium from the CSP, resulting in a gain of $10.

Conversely, if AAPL were to drop to $285, the call credit spread would expire worthless, letting us realize the full $150 premium. And of course, we would get assigned on our CSP. Alone, that CSP gives us a breakeven of $286.40. But the Jade Lizard's call credit spread legs granted us another $150 premium, so our breakeven is actually $284.90. Despite AAPL dropping $1.40 below our CSP's basis, the extra premium from the rest of the Jade Lizard keeps us profitable and we can start wheeling at a $285 basis.

Example of an incorrect Jade Lizard:
STO 1x AAPL $295c for $300
BTO 1x AAPL $300c for $150
STO 1x AAPL $287.50p for $300

Since we are now only collecting $300 from the CSP, we would suffer a loss if AAPL were to rise past our $300 strike on the long call. We would suffer the max loss of $350 on the call credit spread but only recover $300 from the CSP. We would therefore suffer a loss of $50. This is not a proper Jade Lizard because it does not remain profitable when the stock busts the call credit spread.

How can we use Jade Lizards to improve our wheeling?

If it is not clear from the example above, Jade Lizards have two positive aspects in exchange for one risk.

On the positive side, JLs improve your breakeven by letting you realize the full premium from the CCS whenever your CSP gets assigned. Additionally, if the stock falls between your CSP and CCS short strikes, you collect max profit from both sides of the strategy, boosting profits.

On the negative side, you will realize a smaller profit if the stock busts your CCS long strike. While you still realize the full premium from the CSP, the losses from the CCS will offset most of it, leaving you with a smaller profit. Again, you cannot lose money when the stock rises, provided you set up your JL correctly.

Of course, the risk of the stock tanking still exists. If the underlying drops dramatically and you get assigned at a basis very high above the market price, the premium from the CCS will help ice the wound but may not be enough. For this reason, it is important to only wheel stocks you want to hold in your portfolio.

When wheeling, the JL allows us to choose more aggressive CSP strikes because the CCS will grant us additional premium. Likewise, the boosted premiums collected can help us lower our basis more quickly than selling CSPs alone.

Real Life Example

Let's play out a real example on AAPL.

AAPL has adequate options volume and premium to make Jade Lizards a viable strategy.

Let's assume you want to start wheeling AAPL. If you sell the $275p, you'll collect $293 in premium and begin with a basis of $272.07 if assigned.

However, you can add the call credit spread to convert to a Jade Lizard to collect $223 additional premium. That's a bonus 76% premium on top of your CSP.

Notice that the max loss on the call credit spread is $277 ($500 between strikes, minus $223 collected). It is very important that the short put sell for more than that in order to ensure you have no upside risk. In our example, this works because we are collecting $293 from the CSP. If your max loss on your CCS is more than the premium you collect on your CSP, then you will suffer loss if the stock price rises through your CCS; this would be an incorrectly established Jade Lizard.

Here is how this trade could play out:

The key points to recognize here are that:

1) If the stock rises dramatically, the CCS of the JL will negatively affect you, so you would have better off just selling the CSP (this is the risk of JLs).

2) If the stock falls between your CSP and CCS short strikes, you will profit significantly more than if you had just sold the CSP due to the CCS expiring worthless.

3) Your breakevens improve, as demonstrated with this example's $270 expiration price.

4) If the stock tanks, you will still suffer a loss, though it will be more palatable.

Final Thoughts

JLs will not work on low-priced stocks because you are unlikely to find a CSP selling for enough premium to cover the max loss on a CCS. It may be possible if you are looking at an expiration months in advance, but that is a long time to wait to realize the premium.

Robinhood will not recognize a Jade Lizard by name, so double-check your order before submitting to ensure it is established correctly.

JLs have a slightly more bearish bias than CSPs because JLs will become a liability to your portfolio if the underlying rises dramatically.

JLs are best used when IV is high following a recent rise and you expect IV to drop. Decreasing IV will help both your CCS and CSP, so you will profit more quickly when IV drops, even when stock prices do not.

This Jade Lizard method of improving the wheel begs a similar opportunity with the Twisted Sister to improve covered calls. Twisted Sisters are mirrors of the Jade Lizard. This opportunity will be discussed in a later post, but you can get ahead of the curve by visiting  https://www.tastytrade.com/tt/learn/twisted-sister to get some information in advance.

Disclaimer

Mikey created this post in good faith based on his experience and understanding of options strategies. However, Mikey is not a financial adviser. Perform your own analysis before engaging in any trades in the market. If you are not confident, consult a licensed financial adviser.