Christmas Tree Options Spread: A Cheaper Way to Bet on a Measured Move

A Christmas tree options spread is what you reach for when you have a fairly specific view: the stock should rise, but only a little, and you’d like to pay less for that view than a plain bull call spread costs. It uses six options in a 1-3-2 pattern, all with the same expiry. The trade-off is simple to state and easy to forget once a position is open. You give up profit if the stock runs too far.

We’ll build one step by step on a hypothetical stock, work out the payoff at every strike, and then look at what changes when you trade it on an Indian stock where options are physically settled.

What a Christmas tree options spread actually is

According to Investopedia’s explanation of the strategy, it involves buying and selling six options, either all calls or all puts, at different strikes but with the same expiration. The call version is used for a neutral to mildly bullish outlook, and the put version for a neutral to mildly bearish one. The name comes from a very loose resemblance to a tree when the legs are laid out on an option chain. Investopedia itself calls that connection tenuous, and honestly, it is.

The long call version, sometimes just called a call tree, is built like this:

• Buy 1 call at or near the money.
• Skip the next strike.
• Sell 3 calls at the strike after that.
• Buy 2 calls at the next higher strike.

That 1-3-2 count is the tree. Investopedia compares the structure to a butterfly spread, since both stack vertical spreads to box in a target zone. The difference is the skipped strike, which shifts the sweet spot away from the current price and gives the trade a directional lean.

Building the call tree on a hypothetical stock

Let’s use a made-up stock, XYZ, trading at ₹500. Strikes are listed every ₹10, and we’ll assume a lot of 1,000 shares to keep the arithmetic clean. Every price below is hypothetical. Real premiums depend on volatility, time to expiry and liquidity, so treat these purely as numbers to calculate with.

• Buy 1 XYZ 500 call at ₹18
• Skip the 510 strike
• Sell 3 XYZ 520 calls at ₹8 each, collecting ₹24
• Buy 2 XYZ 530 calls at ₹5 each, paying ₹10

Net cost: ₹18 minus ₹24 plus ₹10, which is a debit of ₹4 per share. On a 1,000-share lot, that’s ₹4,000 out of pocket.

Now compare that with the obvious alternative. A plain 500/520 bull call spread with the same hypothetical prices means buying the 500 call at ₹18 and selling one 520 call at ₹8, a debit of ₹10. Its best case is the ₹20 width minus the ₹10 paid, so ₹10 per share. The tree costs ₹4 and, as we’ll see, can make ₹16. That’s the whole appeal in one line. The catch is in where it makes that money.

The payoff, strike by strike

Investopedia gives the rules for the long call tree: maximum profit is the middle strike minus the lower strike minus the premium paid, maximum loss is the net debit, and the two breakevens sit at the lowest strike plus the premium and at the highest strike minus half the premium. Plugging our hypothetical numbers in, here is what the position is worth at expiry. These are our own calculations from the example prices above.

Let’s check a couple of rows by hand. At ₹520, the 500 call is worth ₹20 and every other option expires worthless, so the position is worth ₹20 and the profit is ₹20 minus ₹4, or ₹16. That matches the rule: middle strike 520 minus lower strike 500 minus the ₹4 premium. On the 1,000-share lot, that’s ₹16,000 against ₹4,000 at risk.

At ₹525, the 500 call is worth ₹25, but the three short 520 calls each cost ₹5 to cover, so ₹15 in total. The 530 calls are still worthless. Net value is ₹10, profit ₹6. You can see how fast it falls away: every rupee above 520 takes two rupees off the position, because you are short three calls and long only one in that zone.

The upper breakeven works out to 530 minus half of ₹4, which is ₹528. The lower one is 500 plus ₹4, which is ₹504. Between ₹504 and ₹528 the trade makes money. Outside that band it loses the ₹4 debit, and no more.

The tree is cheap because it is picky. It pays best when the stock lands near one strike, and it pays nothing if the stock overshoots.

Why the skipped strike matters more than it looks

Here’s an observation that’s easy to miss. Look at what happens far above the top strike, say at ₹600. The 500 call is worth ₹100. The three 520 calls cost ₹240 to cover. The two 530 calls are worth ₹140. Add it up: 100 minus 240 plus 140 is zero. The position is flat, so your loss is just the ₹4 you paid.

That only works because of the spacing. The gap from 500 to 520 is ₹20, and the gap from 520 to 530 is ₹10, exactly half. Two long 530 calls then cover the extra short exposure from the three 520s once the stock is above 530. Try the same 1-3-2 count with evenly spaced strikes, say 500, 510 and 520, and at ₹600 you get 100 minus 270 plus 160, which is a ₹10 shortfall before the premium. The loss on a big rally would then be bigger than the debit. So the skipped strike is not decoration. It is what keeps the upside risk capped at the premium.

If you build a tree on a stock whose strikes are spaced unevenly, or you pick strikes from memory on a busy morning, run this same check at a price well above the top strike before you place the order.

The put tree, for a mild fall

Flip everything to puts and you get the bearish version. Investopedia describes it as buying one put, selling three puts at a lower strike, and buying two puts at the next lower strike, for a neutral to bearish view.

Using XYZ at ₹500 again, with hypothetical put prices:

• Buy 1 XYZ 500 put at ₹17
• Sell 3 XYZ 480 puts at ₹7 each, collecting ₹21
• Buy 2 XYZ 470 puts at ₹4 each, paying ₹8

The debit is ₹17 minus ₹21 plus ₹8, so ₹4 again. By our own arithmetic, the best result comes if XYZ finishes exactly at the middle strike, ₹480. There the 500 put is worth ₹20 and the rest expire worthless, so the profit is ₹16. The breakevens are ₹496 (the top strike minus the premium) and ₹472 (the bottom strike plus half the premium). Below ₹470 the six puts net out to zero, the same way the calls did above ₹530, and the loss is the ₹4 debit.

Whenever you read a worked example of this spread anywhere, it pays to redo the payoff at each strike yourself. With six legs, one sign slip changes where the peak sits.

Time decay and the shape of the trade

Investopedia makes the point that time decay works for the holder of a long tree, since you want every option except the lowest strike to expire worthless. In practice that shows up as a trade that often looks unexciting early on and does most of its work close to expiry, if the stock is sitting near the middle strike.

That has two practical effects:

• Early exits rarely capture the full ₹16. Well before expiry, the short options still carry time value, so even with the stock at ₹520 the position will usually be worth less than the expiry table suggests.
• A fast move early can hurt on paper. If XYZ jumps to ₹540 in the first few days, the position can show a loss even though, at expiry, the worst you lose above ₹530 is the ₹4 debit.

Neither of these is a reason to avoid the trade. They are reasons to size it so you don’t feel forced to close it at a bad moment.

What changes when you trade it on an Indian stock

The textbook version usually assumes cash-settled options or a broker that handles exercise quietly. In India, single-stock derivatives work differently. A SEBI circular dated December 31, 2018 made physical settlement mandatory for all stock derivatives, with the move phased in across 2019 expiries. We’ve covered the mechanics in our post on physical settlement of stock F&O.

For a call tree on a stock, that matters. Suppose XYZ expires at ₹525. Your long 500 call is in the money, and so are your three short 520 calls. Held to expiry, the long call means taking delivery of shares, and the three short calls mean delivering shares. The net position may be small, but the obligations are real, and brokers set their own rules on margins and square-offs in the expiry week. Most traders close the whole tree a day or two before expiry rather than find out how their broker handles a six-leg position on expiry day.

On a physically settled stock, the expiry table is a planning tool, not an exit plan. Close the tree before expiry week turns it into a delivery question.

A few other India-specific checks before you place it:

• Liquidity at the far strikes. The 530 calls in our example are the ones most likely to be thinly traded on a real stock. A wide bid-ask gap on two contracts can eat a big slice of a ₹4 debit.
• Six legs, six sets of charges. Brokerage, exchange fees and taxes apply to every leg on entry and exit. On a cheap structure, costs are a bigger share of the potential profit than they are on a simple spread.
• Margin. The three short calls draw margin. Even though the spread’s loss is capped, check what your broker blocks for the combined position before you start entering legs one by one.
• Leg risk. If you enter the legs separately and the stock moves in between, your actual debit won’t match your plan. Where the broker allows it, a basket or strategy order reduces that risk.

When a Christmas tree spread fits, and when it doesn’t

The spread fits a narrow kind of view. Think of a stock you expect to drift up towards a level in the next few weeks, perhaps after results or because of a nearby resistance zone, but which you don’t expect to blow past that level. You want the move to be cheap to own, and you’re fine with a capped, defined loss if you’re wrong in either direction.

It’s a poor fit when:

• You expect a big breakout. A bull call spread or a plain long call keeps paying above the target, while the tree gives it all back above ₹528 in our example.
• You have no view on where the stock lands. The tree’s peak is narrow. If you can only say “somewhere up”, the precision you’re paying for goes to waste.
• The option chain is illiquid. Six legs at poor prices can turn a sensible structure into an expensive one.

If you like the idea of a target zone but want more room above it, a broken wing butterfly is a close relative worth comparing, since it also bends a butterfly’s shape towards one side. And if you’re still getting comfortable with calls, puts and strikes in general, our guide to options trading for beginners in India is the place to start.

The short Christmas tree

There is also a reverse version. Investopedia describes the short call tree as selling one call, buying three at the middle strike and selling two at the top strike, which should bring in a net credit when opened. The maximum profit is that credit. It profits when the stock moves away from the middle strike, and Investopedia notes its bias leans bearish for the call version and bullish for the put version, since a small move in one direction pays faster than in the other.

It’s the mirror image of the long tree, so the risk sits exactly where the long tree’s profit sat: a stock pinned near the middle strike at expiry. For most retail traders, the long version is easier to reason about because the most you can lose is known the moment you enter.

A quick checklist before you build one

• Write down the exact strike you expect the stock to reach by expiry. That is your middle strike.
• Check that the gap between the middle and top strikes is half the gap between the bottom and middle strikes, so risk above the top strike stays capped.
• Work out both breakevens and the expiry value at each strike, as in the table above.
• Look at bid-ask spreads on all three strikes, especially the top one.
• Add up charges for six legs in and six out, and compare them with the maximum profit.
• Decide in advance when you’ll close, and on a stock, plan to be out before expiry.

The short version

A Christmas tree options spread is a 1-3-2 structure that lets you bet on a modest move to a specific level for less than a plain debit spread costs. In our hypothetical example, a ₹4 debit could become ₹16 if the stock finished at the middle strike, with breakevens at ₹504 and ₹528 and a loss capped at the premium on either side. The price for that cheapness is precision: the trade rewards being right about where the stock stops, not just which way it goes. On Indian stock options, add physical settlement, six sets of charges and thin far strikes to the planning, and you’ll know whether the tree is worth decorating.

Disclaimer: This article is for education only and is not investment advice or a recommendation to buy or sell any security. The stock, option prices, lot size and figures in the worked examples are hypothetical. Options trading carries significant risk, so test any approach carefully and speak to a SEBI-registered adviser before trading.