A Christmas tree spread is a complicated options strategy involving six separate option trades. Traders use this strategy when they expect a neutral or slightly bullish market. The strategy can be set up with all calls, all puts and either all long or all short. A Christmas tree spread is like a butterfly spread in that it uses multiple vertical spreads to set up a guaranteed outcome. Because this strategy skips strike price, it has a directional bias more so than with a butterfly spread.

Why Use a Christmas Tree Spread Strategy?

This strategy offers the option trader limited profits in return for limited risk. The long version of a Christmas tree spread benefits primarily from time decay of the option contracts. Traders use this trading approach because it can offer a bit more profit than a butterfly spread and still can be executed with limited risk. It is important to remember that this strategy also benefits from a decrease in implied volatility. It is often set up going into earnings reports with the expectation (hope) that implied volatility will drop.

Christmas Tree Spread Strategy Variations

This strategy can be set up long or short and with calls or puts. A long Christmas tree spread with calls involves buying a call with a strike price equal to the current stock price, selling three calls at a higher strike price and buying two calls at an even-higher strike price. A long Christmas tree spread with puts involves buying a put at a strike price equal to the current stock price, selling three puts at a higher price and buying two more puts at an even-higher strike price.

A short Christmas tree spread with calls involves selling a call at a strike price equal to the current stock price, buying three calls at a higher strike price, and selling two more at an even-higher strike price. A short Christmas tree spread with puts involves selling a put at a strike price equal to the current stock price, buying three puts at a lower strike price and selling two more at an even lower price.

Profit or Loss from a Christmas Tree Spread Strategy

For a long Christmas tree spread with calls the maximum profit is the middle strike minus the lower strike minus the premium paid to set up the trade. The maximum loss for this trade is the price for setting it up including fees and commissions. For a long Christmas tree spread with puts the maximum profit is the middle strike price minus the higher strike price minus the premium paid to set up the trade. The maximum loss with this trade is the debit incurred when setting up the trade. Profit breakout start starts at the lower strike price plus half the premium or at the highest strike price minus the premium.

With both short Christmas tree spread setups the maximum profit is the credit received when setting up the trade minus fees and commissions. For a short Christmas tree spread with puts, the maximum loss is the difference between the highest strike price and the price of the three long puts minus the credit a setup. For a short Christmas tree spread with calls, the maximum loss occurs when the contracts expire with the stock price at the level of the long calls. The maximum loss is 2x the difference between the strike price of the three long calls and the strike price of the two short calls minus the credit at setup.

This is an options trade that is somewhat complicated, has its place in the trading world, and best left to professionals or until you have developed the necessary skills by working with the experts at Top Gun Options.