Options Blueprint Series: All-Time High Christmas Tree Spread

24 jun

Introduction

As Nasdaq futures continue to show bullish momentum, traders are eyeing the potential for a new all-time high. With market conditions favoring upward movements, leveraging options strategies that maximize upside potential becomes crucial. One such strategy is the Christmas Tree Spread, traditionally used to limit risk while maintaining profit potential. However, in this article, we will explore a modified version where all strikes are Out-Of-The-Money (OTM), creating a setup that profit to the upside no matter how high Nasdaq goes. This approach aligns perfectly with the optimistic outlook for Nasdaq futures and sets the stage for potential gains.

Strategy Overview

The Christmas Tree Spread is a versatile options strategy that can be tailored to suit various market conditions. Traditionally, when using calls, it involves buying one call at a lower strike price and selling three calls at higher strike prices and buying two more calls at even higher strike prices, creating a balanced risk-reward profile. In this modified version, we adjust the strikes to all be Out-Of-The-Money (OTM), enhancing the bullish nature of the strategy.

For this setup, while Nasdaq Futures are trading at 19,982.75, we select the following strike prices for Nasdaq futures options with an expiration date of September 2024:

• Buy one 20000 call
  
• Sell three 21500 calls
  
• Buy two 21750 calls
  

By choosing these strikes, we position ourselves to benefit from any substantial upward movement in Nasdaq futures. All strikes being OTM ensures that the breakeven point is set above the current price, effectively betting on a new all-time high for Nasdaq. This configuration guarantees profit to the upside, regardless of how high Nasdaq futures rise.

Strategy Rationale

The rationale behind selecting an all OTM strike setup for the Christmas Tree Spread lies in the current bullish outlook for Nasdaq futures. As markets exhibit strong upward trends, the potential for Nasdaq to achieve new all-time highs becomes increasingly plausible. This strategy aims to capitalize on such a possible bullish scenario.

Why OTM Strikes?

• Lower Cost: OTM options are generally cheaper, reducing the initial cost of setting up the spread.
  
• Increased Profit Potential: Since all strikes are set above the current market price, the profit potential is maximized for any substantial upward movement.
  
• Risk Mitigation: The structure of the spread inherently limits risk, as losses are capped while allowing for upside gains.
  

Breakeven Point: The breakeven point for this modified Christmas Tree Spread is calculated based on the premiums paid and received for the options. Given the strikes selected (20000, 21500, and 21750), the breakeven point is above the current E-mini Nasdaq-100 futures price (20,465.62), aligning with the expectation of a new all-time high.

Detailed Setup and Example Trade

Setup Details:

• Buy one 20000: This is the lower strike option, purchased to gain exposure to significant upside potential.
  
• Sell three 21500 calls: These are the middle strike options, sold to offset the cost of the purchased call and to create a spread.
  
• Buy two 21750 calls: These are the higher strike options, purchased to cap the potential loss from the sold calls and complete the spread.
  

Premiums Involved: Assuming the following hypothetical premiums:

• 20000 call: 683.38 points
  
• 21500 calls: 145.42 each (436.26 total for three)
  
• 21750 calls: 109.25 each (218.5 total for two)
  

Net Cost:

• Total cost of buying calls: 683.38 (20000 call) + 218.5 (21750 calls) = 901.88
  
• Total premium received from selling calls: 436.26 (21500 calls)
  
• Net cost: 901.88 – 436.26 = 465.62
  

Risk Profile and Reward-to-Risk Ratio:

• Maximum Risk: The maximum risk is limited to the net cost of the trade, which is 465.62 points.
  
• Maximum Reward: The maximum reward would take place at 21500 on expiration and is 1034.39 points. The structure ensures 534.39 points of profit as the index potentially climbs higher.
  
• Breakeven Point: The breakeven point is the initial cost added to the lower strike price, which is 20000 + 465.62= 20,465.62.
  

Trade Scenario: To illustrate, let's consider the potential outcomes at expiration in September 2024:

1. If Nasdaq is below 20000: All options expire worthless, and the net loss is the initial cost: 465.61 points.
   
2. If Nasdaq is at 21500: The 20000 call gains 1500, the 21500 calls expire worthless, and the 21750 calls expire worthless. Net gain = 1500 - initial cost = 1034.39 points.
   
3. If Nasdaq is at or above 21750: The 20000 call gains 1500, two of the 21500 calls each lose 250, and the 21750 calls expire worthless. Net gain = $1500 - 750 (total loss from sold calls) – 465.61 (initial cost) = 534.39 points.
   

Risk Management

Risk management is a crucial aspect of any trading strategy, especially when dealing with options. For the modified Christmas Tree Spread strategy on E-mini Nasdaq-100 futures options, several risk management techniques can be employed to ensure that potential losses are minimized and profits are protected.

Use of Stop-Loss Orders:

• Stop-Loss: Implementing stop-loss orders can help limit losses if the market does not move as expected. Setting a stop-loss at a certain percentage below the purchase price can automatically exit the position, reducing the risk of holding losing trades.
  

Hedging Techniques:

• Protective Puts: Purchasing protective puts can provide additional downside protection if the market moves significantly against the position. This can be considered if there are signs of a strong bearish reversal.
  
• Spreading Risk: Diversifying the strike prices or expiration dates can spread the risk and reduce the impact of a single adverse market movement. However, this needs to be balanced with the strategy's intent and market conditions.
  

Avoiding Undefined Risk Exposure:

• Capped Risk: The strategy inherently caps risk by buying the 21750 calls, which limits the maximum loss from the sold 21500 calls. Ensuring that all components of the strategy are correctly implemented and monitored helps avoid unexpected risks.
  
• Regular Monitoring: Regularly reviewing the position and market conditions ensures that the strategy remains aligned with the trader’s expectations and risk tolerance. Adjustments can be made as necessary to manage exposure.
  

By incorporating these risk management techniques, traders can enhance the robustness of the modified Christmas Tree Spread strategy, ensuring that potential losses are minimized while maximizing the chances of achieving the desired profit.

Application with Micro E-mini Nasdaq Options

The modified Christmas Tree Spread strategy can also be effectively applied to Micro E-mini Nasdaq futures options. Micro E-mini options offer the same strategic benefits but with smaller contract sizes (10 times less), making them more accessible for traders with smaller accounts or those looking to manage risk more precisely.

Advantages of Using Micro E-mini Options:

• Lower Capital Requirement: The smaller contract size of Micro E-mini options means a lower initial cost, making it easier for more traders to participate.
  
• Fine-Tuned Risk Management: Smaller positions allow for more precise control over risk, as traders can scale in and out of positions more easily.
  
• Similar Profit Potential: While the absolute profit may be smaller compared to standard E-mini options, the percentage returns can be similar, providing an effective way to capture upside movements in E-mini Nasdaq-100 futures.
  

Comparison of Standard E-mini vs. Micro E-mini Options: Standard E-mini options have larger contract sizes and are typically used by traders with more significant capital to invest. In contrast, Micro E-mini options offer smaller contract sizes, making them ideal for traders with smaller accounts or those who prefer to manage risk more precisely. Both options provide the same strategic advantages but cater to different levels of investment and risk management needs.

Using Micro E-mini Nasdaq futures options provides traders with the same strategic advantage of capturing significant upside potential while managing risk effectively, aligning well with the bullish market outlook for E-mini Nasdaq-100 futures.

Conclusion

The modified Christmas Tree Spread strategy offers a robust and flexible approach to capitalizing on the bullish momentum of E-mini Nasdaq-100 futures. By strategically placing all strikes Out-Of-The-Money and targeting a new all-time high, this setup ensures profit potential to the upside, no matter how high Nasdaq climbs. With proper risk management and precise execution, traders can maximize their gains while minimizing risks. Whether using standard E-mini options or Micro E-mini options, this strategy provides a powerful tool for navigating the current market conditions and positioning for future growth.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: tradingview.com/cme. This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.

General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.