What Is a Christmas Tree Options Strategy?
A Christmas tree is an options trading spread strategy achieved by buying and selling six call (or six put) options with different strikes but the same expiration dates for a neutral to bullish forecast. When using calls, the strategy is termed a long call Christmas tree. It is a put Christmas tree when the trader uses put options.
The strategy is available long (bullish) or short (bearish).
This spread is essentially the combination of a long vertical spread and two short vertical spreads.
Key Takeaways
- A Christmas tree is an options spread strategy that involves 6 call (or put) options: buying one ATM call (put) selling 3x calls (puts) two strikes out of the money and then buy 2x more call (put) three strikes out of the money.
- This strategy pays off with a neutral to slightly bullish outcome in the underlying security.
- Christmas trees can be constructed with either all calls or all puts and may be structured as either long or short.
How Christmas Trees Work
The Christmas tree name comes from the strategy's very loose resemblance to a tree when viewed on an options chain display. The connection is tenuous at best.
Christmas trees are similar to butterfly spreads in that they use multiple vertical spreads to box in a desired potential return. The difference is that one of the strike prices is skipped, which introduces a directional bias.
For instance, if a condor spread involved the 50-55-60-65 strikes, the corresponding Christmas tree would involve just the 50-55-65 strikes (skipping the 60 strike).
The regular, or long Christmas tree with calls (sometimes referred to simply as a "call tree"), involves buying one call option with an at-the-money strike, skipping the next strike, and then selling three options with the following strike. Finally, buy two more calls with the next higher strike. The 1-3-2 structure supposedly appears as a tree.
The strategy profits from a small increase in the price of the underlying asset and maxes when the underlying closes at the middle option strike price at options expiration.
- Maximum profit equals middle strike minus lower strike minus the premium.
- Maximum loss is the net debit paid for the strategy.
- Breakeven occurs at the lowest strike plus the premium paid or the highest strike minus half the premium.
Time decay is on the holder's side as the holder wants all options except the lowest to expire worthless.
Examples
Long Christmas Tree With Calls
For example, with the underlying asset at $50.00:
- Buy 1 call strike price 50.00
- Sell 3 calls strike price 54.00
- Buy 2 calls strike price 56.00
Long Christmas Tree With Puts
With this strategy, the holder is neutral to bearish. Sometimes referred to simply as a "put tree."
- Buy 1 put strike price 50.00
- Sell 3 puts strike price 46.00
- Buy 2 puts strike price 44.00
Maximum profit is at an underlying asset price of 48.00 at expiration.
- Maximum profit equals middle strike minus higher strike minus the premium.
- Maximum loss is the net debit paid for the strategy.
- Breakeven occurs at the lower strike plus half the premium paid or the highest strike minus the premium.
Maximum loss is the premium paid to initiate the strategy.
Short Christmas Tree With Calls
Short strategies should result in a net credit to the account when initiated. This strategy profits when the underlying asset moves by a minimum direction in either direction but it is capped. The bias is bearish because it does not take much of a move lower in the underlying asset to make the strategy profitable. However, a larger move higher may also result in a profit.
- Sell 1 call strike price 50.00
- Buy 3 calls strike price 54.00
- Sell 2 calls strike price 56.00
The maximum profit is the net credit received.
Short Christmas Tree With Puts
This strategy results in a net credit to the account and profits when the underlying moves by a minimum in either direction. Profits come quicker with a smaller upside move although a larger downside move would also be profitable. Therefore, this strategy leans bullish.
- Sell 1 put strike price 50.00
- Buy 3 puts strike price 46.00
- Sell 2 puts strike price 44.00
The maximum profit is the net credit received.
