This is a comprehensive guide to the ZEBRA strategy.

Starting from the origin of the term to the basic setup of the ZEBRA, we will then deep dive into probability cones, risk-reward ratios, the Greeks, breakeven calculations, extrinsic values, and even measuring the angles of the expiration line — the whole works.

Introduction 

The ZEBRA is a stock replacement strategy, among the other stock replacement strategies such as the synthetic long stock, risk reversal, and LEAPS.

ZEBRA stands for Zero Extrinsic Back Ratio, a term coined by Liz and Jenny in their TastyTrade show.

As the name implies, it is just a back ratio spread, which is covered more in-depth in another article.

However, the strikes are selected in such a way that it mimics a stock, but with less capital and with defined risk.

The strikes are selected to wash out extrinsic value, which gives it an advantage over just buying a call or a put.

Trade Setup 

Buy two 70-delta in-the-money options.

Sell one 50-delta at-the-money option.

Use all calls if going long.

Use all puts if going short.

An example of going long would be:

Date: Dec 21, 2020

Price: AAPL @ $128.23

Sell one AAPL Jan 15, 2021 – $128 call @ $4.925 (at delta=53) (25 days till expiration)
Buy two AAPL Jan 15, 2021 – $122 call @ $8.55 (at delta=71)

Net Debit: $1217.50

The payout diagram looks like this with the expiration breakeven point close to where the current price is.

If the price goes up, the investor profits.

If the price goes down, the investor’s P&L goes negative.

Just like owning stock, there is a 50/50 chance that the price will either go up or down.

The probability of profit in with this strategy is 50-50.

ZEBRA Strategy Trade Management 

Since this is a stock replacement strategy, we manage it like a stock.

The thesis for going long on AAPL is the technical pattern of a bullish candle bouncing up from the 8-day moving average, which is also above the upward sloping 20-day simple moving average.

RSI is stair-stepping upward, but not in overbought territory.

There is no immediate overhead resistance.

So, there is still room for AAPL to go up.

If the technical pattern does not play out and AAPL drops below $125 which is below the 8 EMA and below the candle open, that would be a good place for a stop loss.

Looking at the payoff graph, we can lose from $250 to $500 depending on how long we’ve been in the trade and how volatility has changed when this happens.

In order to have a reward to risk ratio of around 1.5, we make a note to exit the trade with profits if our profits gets close to $500.

From the payoff graph, this should happen when AAPL price gets to $133.

Not unreasonable at all.

In fact, AAPL reached $133 at some point in the next day on December 22, 2020.

However, you are not likely to have caught that unless you were watching the screen all day.

A better way would be to have set an automatic order to exit the trade with profit at that level.

What is the Max Loss? 

The ZEBRA strategy is a defined risk strategy where the max loss is the debit paid.

The max lost for the AAPL ZEBRA would be $1217.50.

A more aggressive investor willing to possibly hold till expiration might think to let the max risk be the stop loss.

We don’t recommend that, but let’s see.

For a 1.5 reward to risk ratio, the investor would need for profits to reach $1826.25 before taking profits.

For this to happen, AAPL price would need to reach price of $146.44 at expiration Jan 15, 2021.

While certainly possible, it may be a stretch.

According to the probability cone provided by OptionNetExplorer, this is about a 1.5 standard-deviation move.

The chances of price moving more than one standard deviation is only 31.8%.