Tag Archives | calendar spread

Is it still a Calendar Spread?

Mark,

I am wondering about proper management of a multi-month calendar spread. I initiated the position in November with selling the Nov 40 call and buying the June 40 call. The stock price at that time was around $37 and I had a bullish bias. The stock has trended up and so far the Nov, Dec, and Feb calls that I sold all expired worthless. In Feb I increased my short strike to 41, and it closed just above $40 last Friday.

So now my long June 40 call is in the money, and I will probably look to sell a March 43 call.

My question is this – if my bias remains bullish, is the proper strategy to just keep holding the long June 40 call and keep selling short calls with higher strike prices, or is it smarter to just sell the June 40 call and initiate a new calendar at the 43 strike price (sell March 43/buy June 43)? In my studying of options I haven’t seen this topic discussed – but it seems to me that replacing the June 40 with the June 43 would lock in profit and reduce risk if the price goes down from here and is probably the smart move. Would there be any good reason to not do this? Thanks.

sandeep

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Stock Trader Moving into Options

Hi Mark,

I am a longtime stock trader, but over the past couple months, I have taken a real liking to the options game. Your blog has been a huge help in understanding many of the aspects I've been reading about.

So I was wondering a couple things:

1. I notice you trade RUT. What it is about this index that draws you to it? And a more general question is, what do you look for in a stock or index for IC/credit spread trades?

2. What are your thoughts on a strangle comprised of an out-of-the-money call spread and an out-of-the-money put spread, both bought in large lots at low delta, say .20-.25 per spread, both puts and calls? 

[See reply for comment on the word 'delta'.  It should be 'cost']

As long as I am confident of movement in the life of the options, one of the spreads will pay for the other, especially if one moves ITM… If the stock tends to swing, both sides can be closed for a nice profit.

Today's (Jul 16, 2010) hammering of the financial sector and the market in general, has made this very tempting, especially ahead of earnings.

I also own a 25 lot, low delta Jan 11 VXX call spread to hedge my portfolio, and it seems to be working okay as the spread moved from .70 to .85-.90. Is there anything I'm overlooking with this strategy?

I have not seen much advice online about using debit spreads to put on a strangle position, so I get the impression it is not used by many traders.

[Once again, 'strangle' is not the term you want to use]

My thought process is that buying a spread with ~ 25 delta and selling for $0.40 or .50 is like buying a $25 stock (albeit one that expires) and having it rally to $40 or $50, even though the underlying stock is only moving a dollar or two.

3. I am currently long PG Oct 60 calls. I paid ~ 2.50 on a market dip and when PG rallied three points, I sold Aug 60 calls for ~ 2.50 and plan to take advantage of time decay and exit both as a calendar spread. I may get a chance to buy to close the Aug 60 calls for a song, and still be long my Oct 60 calls.

Good move or is there something I'm overlooking? I am slightly worried that someone will exercise the August calls for the upcoming dividend, and am tempted to take my profit on the spread if there is a high risk of that.

Any advice or critiques would be most welcome. At this stage, my comfort zone is being long either naked options (giving me the option to leg into an instantly profitable debit spread, or sell to close) or debit spreads.

Andy

 
***

Welcome to the options world Andy. 

1) Regarding RUT: I prefer to trade European style options because they settle in cash.  I'd prefer SPX options, but trading those is inefficient for me.  

I don't trade stocks.  My requirement would be 'plenty of strikes' – and that eliminates all mid-priced stocks

 

2) I must
correct an error in terminology.  We must speak the same
language to communicate.

You are writing about low cost spreads, not low delta spreads. [Delta is the rate at which an option's price changes when the underlying stock moves one point].  Spreads can have 'low delta' but I see from your continuation that you are referring to spreads that are low priced.

Correct: If you get a big enough move and if you get it quickly enough, you can earn a nice profit.
To get a profit from both sides, you need a pretty good-sized swing. Plus, you must have a good knack for exiting one side at an opportune time. Double profit is a rare bonus.  Don't think about it. The game is to win on one side.

I have nothing against that strategy in principle. However, I take exactly the opposite position in my trading.

I sell those credit spreads (that's an iron condor position, not a strangle) and hope to profit from lack of movement, time passage, or shrinkage in implied volatility. In reality we can both win when taking opposite sides of the same trade – depending on how adjustments are handled and on our timing of trades.  However, I obviously prefer my side to yours – but I am NOT suggesting that you change.  You are okay preferring your side.  Our results depend on how well we handle position risk.

I am not paying enough attention to VIX and VXX to give a good answer and don't want to say the wrong thing. But VXX is much better to trade than VIX. In addition, you have it right. A down market should result in an increase in the implied volatility of the options, and that moves VXX higher.  When VXX is higher, your spread should gain value.

You have not seen much advice online about 'using debit spreads to put on a strangle.' That's because you have the terminology wrong (no big deal).

A strangle consists of naked options (long or short), not spreads. The position you are describing is the iron condor, and not a strangle. The iron condor is VERY popular.



Buying a spread @ $0.25 and selling @ $0.40 is similar to trading penny stocks and paying 25 cents and selling at 40 cents.  It's not like a $25 stock and a $40 stock.


3. Your PG plan is viable.

But you must know this: calendar spreads get narrower (lose money) when the stock runs away from the strike price in either direction.

In my opinion, it's easier to take your profit by selling the Oct option, but selling the August call does give you a position with the opportunity (that's all it is) to earn extra profit.


I suggest you consider an alternative when you own a profitable trade.

First, do you still want to remain long this option at the current price level for the stock? If no, sell the option, take your larger profit and move on. If yes, then it's okay to do as you suggest and find a hedge.

But know this: You are not locking in an instant profit. This is a common misconception.

You are taking your own personal money, the profit you already earned, and reinvesting it into the call spread – when you could have sold and kept the entire profit. When you exit, the cash belongs to no one but you (and the IRS).

When you hedge the trade – even at a wonderful price – you do not have an INSTANT PROFIT.  You earned that profit.  So decide:

  • Sell and take the money
  • Reinvest part of it into a a new, hedged trade

In other words, do as you suggest – ONLY when you believe the new position (in this case a calendar spread) is the place to invest your cash.

Enjoy your options.

744

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