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Option StrategiesOptionsOptions strategies

Trading In Christmas Tree Spread With Put Option Strategy

Written by Aaditya Shah (Individual Contributor)
Sat Mar 06 2021
MarketXLS Christmas tree with put options template
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MarketXLS Christmas tree with put options template
 

A Christmas tree spread with put option strategy involves buying and selling six put options of the same underlying asset with the same expiry date but with different strike prices. This strategy generally involves buying three puts and selling three puts.

Christmas Tree Spread with put option strategy

Key features of Christmas tree spread with put option strategy

  • Bearish in nature

As the trader uses puts in this strategy, there is an expectation that the prices will fall. Any price rise will not impact this as both the parties, i.e., buyer and seller of put options, will not exercise their selling rights as they would be bearing a loss. 

  • 1-3-2 Structure

In this strategy, the trader first enters one buy put at-the-money strike. Then, the trader would sell three put options after skipping a strike price. Finally, the trader would buy one put at the following price. This 1-3-2 structure resembles a Christmas tree and thus, the name Christmas tree spread with put options strategy.

For example, a stock has a current share price of $100. Using the Christmas tree spread strategy, the trader would enter 1 buy put at $100, skip the $95 strike price, sell 3 buy puts at $90 and buy 1 put at $85.

  • High-profit potential with limited risk

This strategy, when appropriately used, offers a good profit to the trader along with limited risk. The net premium paid is the maximum loss that traders can incur using this strategy. 

Let us understand this strategy better with the help of a detailed example.

The current share price of Microsoft is $240.97. If the trader believes that the stock price would be declining slightly in the coming future, he will use the Christmas tree spread with put options strategy. The trader would buy one put with a strike price of $240, sell three puts with a strike price of $230 and buy one put with a strike price of $225. The table below shows different strike prices of various options carried out:

Option Strike Price  Position Quantity
Option 1 240 Buy Put 1
Option 2 230 Sell Put 3
Option 3  225 Buy Put 2

Consider three different market scenarios to understand the risk-return ratio better:

  1. Spot Price at $240 on options expiry: The trader will not exercise the $240 buy put option as he will not profit from it due to the spot price on options expiry being the same as the strike price. The trader will not exercise the $225 buy put option as he will bear a loss of $30. In the case of the sell put option of $230, the opposite party, i.e., the buyer of put option, will not exercise the option as he will suffer a loss of $30. 
  2. Spot Price at $230 on options expiry: The trader will exercise the $240 buy put option as he will get a profit of $10 compared to the spot price. The trader will not exercise the $225 buy put option as he will bear a loss of $10. In the case of the sell put option of $230, the opposite party, i.e., the put option buyer, will not exercise the option as he will not profit. 
  3. Spot Price at $220 on options expiry: In this case, Option 1 and 3 will be exercised by the trader as he gets a profit of $20 and $10, respectively. The opposite party will exercise option 2 as he will earn a profit of $30 as the spot price is lower than the strike price.

Maximum Profit/Loss in all the scenarios is as given below:

Scenario Spot Price on Expiry Maximum Profit/Loss
1 $240 Net premium received/paid
2 $230 $10 from option 1 + Premium received from option 2 – Premium paid in option 1 and 3
3 $220 $30 from option 1 and 3 – $30 from option 2 + Premium received from option 2 – Premium paid in option 1 and 3

Maximum Profit, Loss, and Break-even in Christmas tree spread with put option strategy

The strategy will give maximum profits when the share price at the expiry of the underlying asset is equivalent to the middle strike’s strike price. In the above case, the trader gets maximum profit when the share price on Microsoft’s expiry is equal to $230. The net premium paid would be the maximum loss in this strategy. 

The maximum loss in Christmas tree spread with put option strategy would be the net premium paid. Breakeven is achieved at the lower strike plus half the premium paid or the highest strike minus the premium in this strategy.

How to use Christmas tree spread with put option strategy using MarketXLS?

MarketXLS is an excel based platform with 600+ functions for stock and options analysis. Using a Christmas tree spread with put option strategy with the help of MarketXLS is quite simple. The user only needs to take the following steps in the template provided by MarketXLS:

  1. Mention Stock ticker
  2. Enter the Expiry date of the option. A list of upcoming expiry dates is provided to the user adjacent to the input.
  3. Enter the Highest Strike price and the spread between the strike prices.     

MarketXLS Template(Users only need to enter the information marked in yellow in the above image. The below image shows the results users will receive after inputting the required information above.)

MarketXLS Christmas tree with put option strategy template

MarketXLS will make things easier for the trader by directly allowing them to observe the maximum profit and loss they would make using the Christmas tree spread with put option strategy. MarketXLS would also enable the trader to observe the maximum profit and loss at different strike points, helping him choose the best strategy according to his/her requirements.

References:

https://www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/long-christmas-tree-spread-puts

https://optionstrategiesinsider.com/blog/christmas-tree-spread-with-puts-option-strategy

Disclaimer:

None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person.

The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein.

The article is written for helping users collect the required information from various sources deemed to be an authority in their content. The images, copyrights, and trademarks if any are the property of their owners, and no further representations are made.

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