We have been hearing increasingly about complex option strategies of late, and today we add the "Christmas tree" to our trading lexicon.
Christmas trees are similar to the ratio spreads we recently discussed: You buy one put (or call) and sell two further out-of-the money puts, just like with a ratio spread. But in the Christmas tree, you use different strikes.
In CNBC's "Options Action" show Friday, Stacey Gilbert suggested a Christmas tree in the QQQQ Nasdaq 100 ETF. The specific trade cited (with Friday's prices) was buying the December 40 puts for $2.15, selling the December 36 puts for $0.95, and selling a December 32 put for $0.40 for a total cost of $0.80.
The trade protects down 10 percent and doesn't get long the market (through the extra short put) until the market drops 29 percent. Selling the two puts reduces the cost of the protective 40 puts.
Gilbert pointed out that this is not the trade you want if you think the market is going to drop 20 or 30 percent quickly, but it does provide low-cost protection if the market grinds lower.
The show also included an interesting discussion of a straight zero-cost collar on JC Penney versus a calendar collar. The zero-cost collar that Mike Khouw suggests involves selling an out-of-the-money call and buying an out-of-the money put--against stock--for the same prices.
The calendar collar that Gilbert recommended involves buying the September 30 puts for $0.80 and selling the October 34 call for $0.85. She recommended this because the implied volatility in October is higher, and as Scott Nations says, she is "paying attention to the term structure."
I would highly recommend that anyone following this type of strategy run it through a position simulator. Any time you are using different expirations in a trade it becomes very difficult to make profit-and-loss projections. (See our Education section)
(Chart courtesy of tradeMONSTER)