Weekly calendar with RIC

[fradav 1]

H Kim, when trading the weekly calendars, would it not be a good hedge to place OTM RICs (vertical credit spreads) on the calendar breakeven points?

 

I know it's hard with RUT with 10 point increments and low liquidity, but on a stock like aapl the far OTM options are so cheap you can almost elminate upside and downside risk if you set the trade up properly, albeit at the expense of some profits should the calendar work as intended.

 

It doesn't work on monthlies, the zone between the 90% probability calls and puts needs to be narrow, as it is for weeklies.

 

The only caveat is this works on my options express trade calculator and I've found out it can't be trusted for P/L on calendars.

[Kim 7,512]

Interesting idea. It does flatten the P/L chart a bit, but in case of big move, you still lose. With RUT, you actually can do this RIC with monthlies and 5 points increments. Worth some more investigating.

[fradav 1]

I've tried it (paper) with RUT, SPX and AAPL and get best results with AAPL,

 

85% OTM 5 point RIC costs about 40 to 50c per spread with 10 days to expiry and are highly liquid. More importantly, I get a wider profit zone with the AAPL calendars, either single or double, which I assume is due to the fact the premium/IV is more in relation to stock price as compared to SPX and RUT. The indexes are more narrow or leave a steep dip in middle of tent with a double.

 

As you say you can still lose if there's a very large move but it looks like there would be a high probability of profits most weeks (if my trade calc works). But there's normally a catch.

Edited September 25, 2013 by fradav

[tjlocke99 18]

fradav,

 

could you give an example of the legs of this trade with strikes and dates?  I'm not understanding how you could lose in a large move?  I thought with a RIC large moves wouldn't matter.

 

what does this mean "85% OTM 5 point RIC"?  not sure what the 85% means?

 

also does it have to be weeklies?  what if the RIC or calendar was actually at a different date?

 

thanks!

[fradav 1]

For example if I was entering it today on aapl I'd place a double calendar Oct wk2/Oct wk1 470 for the puts and 490 for the calls, 10 contracts, cost $4700

 

I'd hedge it with 2 Oct wk 2 debit spreads (buying the strike closer to the stock price), 455/450 puts and 505/510 calls, 10 contracts, cost $800

 

The breakevens of the calendars are 459 and 502. The breakevens of the RICs are 505 and 454. 

 

The max loss on the calendar is total paid,  4700, and the ICs payout 4200 if it's over 510 or under 450.

 

So hard to lose (again if my calc is right, seems too good to be true).

 

When I say '85%' I just mean 85% chance of being out of the money, around .15 delta if you prefer.

[fradav 1]

...one more point, by my calculations it works best on weeklies, first because you need a narrow probability range of for the calendar, but also because you need a very cheap OTM hedge, otherwise it kills profits on the calendars. The gamma risk associated with weeklies is eliminated by the OTM RIC hedge so you can sit and wait until expiry for max theta burn on the shorts

Edited September 25, 2013 by fradav

[Kim 7,512]

Okay, just plugged it into ONE software:

 

 

The blue chart is the original chart at expiration, the green one includes the hedge. So it does prevent a catastrophic loss if AAPL gaps 30+ points (you still lose 20-25% but not ~50%+. But on "normal" movement it doesn't help you that much, and in fact, significantly reduces the gains. 

 

btw, I would not go as wide as 470/490. Would probably start with the same strike like we do with RUT.

[fradav 1]

Thanks for feedback Kim.

 

Bizarre, your calculator gives a very different result from mine. Without using software, we can calculate that the 455/450 IC is worth $4200 at 450 (5000 minus the 800 paid), and when the calendars only cost $4700, I can't work out how your software has a 50% loss at 450. 

 

The max draw down on calendar profits is $800 which may be compensated for by ability to stay in trade until expiration.

 

Anyway, I'll paper trade it and see how it goes.

[Kim 7,512]

The 50% loss is without the hedge. With the hedge, it's 20-25% loss. The 455/450 IC is not worth 5000 at expiration of the shorts (week1) because there is still time value left. So if on Oct. 4 AAPL is at 450, your calendar lost 100% (4700) but the 455/450 is worth around $3000 because there is still one week to expiration. If you continue holding and AAPL goes back above 455, you can lose on the RIC too. Becomes a bit tricky.

 

You can do the RIC at week1 (when the shorts expire) but then your P/L looks really bad around the RIC longs(505/455).

[Kim 7,512]

P.S. yes, actually it is almost 50% loss at 450 at expiration which is week1. And this is because the 455/450 is still worth less than 3000, and the second debit spread and the calendar are worthless.

[fradav 1]

Thanks again Kim, much appreciated.

 

I actually meant to have the IC at the same expiry as the shorts (wk 1), not the longs (wk 2). But understand it's not good around the RIC longs.

 

I'll play around with it, only option would be taking the RIC in 5-10 points but then the profit of the calendars will of course decrease, maybe there's a sweet spot. Not sure how much the ability to hold the entire trade into expiry without adjustments helps, I'll find out. 

Edited September 25, 2013 by fradav

[Kim 7,512]

Yes, I think RIC at same expiry as the shorts might be a better idea, and you can set a rule that you are out at least 2 days before expiration no matter what. This probably should be a no touch trade - you either hit the profit target or are out 2 days before expiration.

[fradav 1]

This is the P/L (RIC left, DC right)  if I take the RIC shorts into 465 and 495, still with a DC 470/490 (I know you recommend closer in or a single calendar but it means the RIC has to get closer, and too expensive). There's no huge win. but it should give a few thousand dollars per 10 contracts over a fairly wide range. Will give it a run tomorrow and see how it goes. Agree, no need to touch it other than take off a few days before if profit target reached.

 

 

[tjlocke99 18]

So the reverse iron condor is at the short week of the calendar?

 

what about keeping the RIC at the long week, but doubling the # of contracts?

 

Another way you can lose is if IV goes down.  The RIC and the calendar are both long vega trades, so if IV collapses you lose.

 

Kim - what is this you reference about doing this on RUT?  Are you doing calendars with RICs on RUT?  Is there some metric you are looking at that makes these trades attractive?

 

Thanks!

[Kim 7,512]

This is the P/L (RIC left, DC right)  if I take the RIC shorts into 465 and 495, still with a DC 470/490 (I know you recommend closer in or a single calendar but it means the RIC has to get closer, and too expensive). There's no huge win. but it should give a few thousand dollars per 10 contracts over a fairly wide range. Will give it a run tomorrow and see how it goes. Agree, no need to touch it other than take off a few days before if profit target reached.

Okay, now this is what I get for expiration and T+6 charts:

 

 

So at expiration it doesn't look very attractive, but on T+6 (next Wednesday) it looks not bad if AAPL stays between 460 and 500. And if it jumps 35-40 points, the loss is still only 15-20%. But the gains are also limited to 8-12% best case.

[fradav 1]

Thanks for the heads up Kim, I'm clearly being misled by my OptionsExpress trade calculator. I can see that even on a simple calendar spread it's grossly over-predicting profits. Here's how off their prediction of a 470/490 calendar is, way off. I need new software.

Edited September 26, 2013 by fradav

[tjlocke99 18]

Thanks for the heads up Kim, I'm clearly being misled by my OptionsExpress trade calculator. I can see that even on a simple calendar spread it's grossly over-predicting profits. Here's how off their prediction of a 470/490 calendar is, way off. I need new software.

 

what if you bought the RICs 2 weeks out and used 50% more of them?  how would that p&l look?  what about doing this with a regular calendar (not a double calendar).

[fradav 1]

The RICs need to cover the shorts, so need to have same expiry. They'd be too expensive 2 weeks out and would probably eliminate any gains on the calendar. But I guess there's 2 ways of looking at the trade, using calendars to hedge an RIC (for example through earnings) or vice versa, depending on what your goal is. 

 

I think it could be set up on aapl so there's a very high probability of success, I don't have the software to test it so am working out variations manually.