Option Strategies – Where Do These Unusual Names Come from?

(Editors Note:  While at the 31st Annual Options Conference April 24th to 26th, Jack Warner from ivolatility.com asked me “What is the name of a strategy where I have a short put combined with a bullish call vertical spread”?  He stumped me, but I remembered I did an article for SFO magazine in their Aug. 2009 edition regarding unusual names.  Here it is.  I didn’t cover every strategy, if you send one in we’ll do a follow up for all to see.  Enjoy!)

 Iron Butterfly, Back-Spread, Condor, Christmas Tree.  Of all the subsections that make up the financial service industry, it seems that the options world has cornered the market for unusually named investment strategies.  Have you ever wondered where these odd names originated?  You’re not alone.  I’m serious.

 In my travels for the Chicago Board Options Exchange (CBOE) I talk to traders, investors, fund managers, you name it.  A regular question is “where did these names come from”?   My usual answer is “we have a room on the floor of the CBOE, and when a new strategy comes along, we reach in and pull out a random name”! With no definitive source, I decided to see if we couldn’t find out something more.

 Listed options arrived at the CBOE in April of 1973, 16 stocks, calls only.  But the story of options goes back to the days of “Put and Call” brokers.  Your order to trade options would go from your broker to his or her trading desk, where traders would place phone calls to brokerage firms specializing in options – “over the counter” Put and Call brokers.   There were about twenty-five members of the Put and Call Dealers Association in the early 1950’s. 1 Herb Filer in his 1959 book talks of options going back to Holland over 300 years ago at the time of tulip trading, and long before then.  His examples included the familiar Straddles and Spreads, but mentioned a few strategies seldom heard these days – Strips (a position employing 2 Puts and 1 Call) and Straps (1 Put and 2 Calls).  So if Filer, who started in the business in 1919, was mentioning Straddles and Spreads, these are not new terms.

 The consensus from several long-time option traders including Larry McMillan of McMillan Analytics and Andy Schwarz, Principal at Integral Derivatives in New York, is that as option trading moved from the over-the-counter world to the CBOE and later other exchanges, upstairs traders didn’t want a strategy known by one name on one exchange being called something else at another exchange.   Bill Brodsky, Chairman of the CBOE, said that most strategies used by over-the-counter Put and Call brokers weren’t complicated. For the most part they were straight buy or sell orders. With the advent of standardized terms, investors and traders began to combine a few simple strategies into more sophisticated strategies, and these strategies needed to be named.

 But this is where my investigation got interesting – and fun.  As I started calling traders I knew to inquire as to the origin of these names, they had few answers, but helped confuse me by mentioning strategies I had forgotten about.   I was able to find the origins of a few terms on the web.  For example Wikipedia said the term “Contango” came from the London Stock Exchange in the 19th century.  Backwardation would be the opposite of Contango. But those are futures terms, not options terms.

 (Note:  some of the following are margin and commission intensive, you’ll need permission from your broker to employ them).

 Guts – Dave Westhouse at PTI Securities – Sell an In-The-Money (ITM) Call and an ITM Put.  Both options should have some time-premium. This would be somewhat delta neutral, and you would ordinarily close these options the week of expiration prior to being assigned (If assigned early, close remaining option and stock position immediately).

 Mombo-Combo – Clay Struve at CSS – This is now known as the Covered Combination (Combo).  Buy 100 shares; sell an Out-of-The Money (OTM) Call and an OTM Put.  Call sale is covered by long stock; short put may make you long additional 100 shares if the stock trades down sharply, but that may be your intention.  You are long stock, collecting two premiums.

 Butterfly  – Bud Haslett at Miller Tabek –  It comes from the shape of the P & L graph, very symmetrical. Limited risk, good potential gain, commission intensive.

 The Box – also Bud Haslett – This is a strategy that explains a lot about a lot!  This is a call and put spread – both a debit or both a credit.  Let’s take XYZ at $48.  If you own the 45 – 50 strike call debit spread and also own the 50 – 45 put debit spread (this looks like a box), at expiration, no matter where the stock is (OK, if the stock lands exactly at one of the strikes – another term, pinned – it gets interesting), the box must go out at $5.  Bud told a story (I remembered this happening to me, and this is very, very unusual) of a partial tender, where $5 boxes went for $8 or $10.  The 45 strike call might be exercised in order to tender stock, and as the shares not tendered fell afterwards, the deep ITM put was very valuable.

 Jelly Roll – A verb or a noun.  To roll a Spread or Box from one month to another, or a synthetic short in one month and a synthetic long in another.  I knew it as the verb, most now know it as a noun. There, I hope we cleared that up.

 Surf & Turf – Tom Haugh, CIO of PTI Securities – You know this as the Strangle.  If one were to sell the Strangle and the underlying landed in the middle so both positions expired worthless, your restaurant order was the Surf and Turf on the Saturday after expiration.  (Tom also mentioned “Sell the 280’s (OEX calls) and buy a Mercedes”, which worked until it didn’t.  Most traders talked a good story about selling naked short options, but in reality Tom and I know most sold credit spreads).

 The Collar – In ancient times (the 1980’s and before) the Collar might have been known by a few different names – The Fence, Hedge Wrap or Hedge Wrapper.  All convey the idea of limited risk.  The late Harrison Roth used to use the term “Two-Way Stretch”, which no one uses (unless you’re into NASCAR) and is also confusing.  The Fence was more of a Futures term.

 Vertical Spread – I agree with Brian Overby of Trade King.  Computer screens on the trading floors would list all of the June call options.  If one wanted to buy a June Call and sell a June Call, they were above or below each other – vertical.  If someone wanted to buy an October call and sell a July call, an October might be on the screen next to the July, horizontally.  A Time-Spread or Calendar Spread was easy to comprehend, and a Horizontal Spread is the same as the previous two.  The Double-Diagonal is a more recent phrase for two credit spreads, a call credit spread and a put credit spread.  A little more descriptive than an Iron Butterfly.

 The Back Spread – It’s a ratio spread where one owns more contracts than one sold.  The Back Spread can sometimes be initiated for a credit, and if the underlying moves sharply can be rewarding.  But there is a point where the closer to ATM option may end up ITM and cause a loss on the trade.  I heard Alex Jacobson (now with OptionsXpress) call this a “Pay Later Spread”, which gives an almost perfect visual on the P&L graph.  I wanted to give Alex credit for this, but he said he heard the term used by Leon Gross at Citi, and it might have been trademarked!  So if it has, congrats to Citi.

 Jon Najarian (DRJ) remembered hearing a story about a large, multi part option trade going up in an index product years ago.  A media person heard about the trade and contacted the trading crowd.  He asked the name of the strategy and was told “Oh, that was the ‘Smith’ trade”.  (note, the name of the trade has been changed for this story, it was a notorious celebrity in the news, known for being a non-nice celebrity).  The media person published a story mentioning the “Smith” trade, much to the delight of the trading crowd.  The trading crowd was given a verbal reprimand by CBOE’s PR department, but this shows how oddly named strategies seem to multiply, and no name is too crazy!  And couldn’t any of us be fooled by one of these unusual names?

 Joe Cusick of OptionsXpress says the strategy he thinks has the most interesting name is “Tarzan Loves Jane”.  This is one of my favorite named strategies too.  It consists of a Call Time-Diagonal Ratio Spread and a Put Time-Diagonal Ratio Spread (that’s a mouthful)!  Here it is.  With XYZ at $50, sell two of the 30-day 45 strike puts and two of the 30-day 55 strike calls.  Buy 3 of the 6-month 40 puts and 3 of the 6-month 60 calls (pick you own ratio, but you want to own more of the OTM options.  The options you own are of longer duration.  One would hopefully get to write OTM Calls and Puts repeatedly on the front month.).  Where do Tarzan and Jane come into this?  Look at the P&L, it reminds some (not me or Joe) of Tarzan swinging through the vines, with multiple break-even points with great potential if the underlying goes nowhere or breaks sharply lower or higher.

 Broken Wings have come to mean a non-symmetrical, multi-part strategy. Buy two put options of strike A, sell three puts of strike B, and buy one put of strike C (and let’s make the difference from strike B to C double that of A to B).  This could be a Condor, a Butterfly, any multi-part strategy.

 Tom Sosnoff (at Think or Swim when the article was first published), told me that when TOS was setting up their software for investors, the consensus was “What does the term Iron Condor or Iron Butterfly tell an investor about a strategy?  If we were to start from scratch, what titles make more sense”?  His group re-named a few strategies to help simplify the terminology.  A “Straddle – Strangle Swap” – buying one and selling the other – might be easier for an investor to comprehend than an Iron Butterfly.

 This is just a first-step in a compilation of the origins of option strategy names.  I’m putting out a challenge to you readers.  If you know the origin of any of the names of option strategies I mention (or didn’t), e-mail me at kearney@cboe.com.   I would love to hear from you.  Although we may not get to the bottom of the bizarre names, at least we can have a little fun.

1.       Herb Filer Understanding Put and Call Options 1959, Crown Publishers, NY, NY.

  • whew! what a read! It was long but very informative. I hadn’t even heard about some of those strategies before like a “christmas tree”. cool.