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  1. Calendar spread options strategy A calendar spread is a strategy used in options and futures trading: two positions are opened at the same time – one long, and the other short. Calendar spreads are also known as ‘time spreads’, ‘counter spreads’ and ‘horizontal spreads’. The calendar spread offers the flexibility to utilize either ATM (at-the-money) strike prices, resulting in a directionally neutral trade, whereas OTM (out-of-the-money) strike prices introduce a directional element to the trade. The variation enables traders to lean into a bullish or bearish position, depending on your market outlook or risk appetite. Elements of the Calendar Spread How the calendar spread makes money? The first way a calendar spread options strategy makes money is the theta (time decay). The idea is that the near term option is losing value much faster than the back month option. Sounds good, doesn't it? The problem is that the stock will not always act according to our plan. If the stock makes a significant move, the trade will start losing money. Why? Because if the stock moves up significantly, both options will have very little time value and the spread will shrink. The second way a Calendar Trade makes money is with an increase in Implied Volatility in the far month option or a decrease in the volatility in the short term option. If there is a rise in volatility, the option will gain value and be worth more money. When implied volatility increases, it will usually increase more for the long term options since their vega is higher. The trade is vega positive which means it benefits from the increase in implied volatility. Time Decay Trade Options, as financial instruments, have a finite lifespan. The greater the time remaining until an option expires, the higher its time value. Consequently, options lose value with each passing day, which is why selling options is an essential tool in the option trader’s toolbox. The measure of this time decay is known as theta. Theta essentially measures how much value an option will lose each day. However, the issue with selling options is the presence of unlimited risk. Given that a stock’s upside is theoretically infinite, selling a call option leaves you exposed to potentially unlimited losses. A calendar spread capitalizes on time decay, also known as theta decay, while simultaneously hedging the unlimited risk by purchasing a longer-term option. Market Neutral (Delta Neutral) Or Directional The conventional approach to the calendar spread involves selling a short-dated at-the-money (ATM) call or put option and simultaneously buying a longer-dated ATM call or put. For instance, let’s consider an ATM calendar spread in SPY. SELL (1) SPY 21 APRIL $409 CALL @ $5.38 BUY (1) SPY 19 MAY $409 CALL @ 10.72 Net Debit: $5.34 By choosing ATM strike prices, we’re not overly concerned with which direction the underlying stock moves. Ideally, the stock barely moves and hovers around our strike price. However, because we chose call options for this spread, we have a slightly bullish directional bias, as you can see in payoff diagram below: But, remember, the beauty of options trading is that it enables creativity. We can morph the “textbook” options spreads to match our market outlook or desired exposure. So for instance, if you wanted to take advantage of theta decay in a hedged manner but dial up your directional bias, you can achieve this by tweaking the strike prices of your options. Let’s take a look at how altering the strike prices changes calendar spreads. First, we’ll look at an out-of-the-money (OTM) call calendar spread in SPY. We’ll use a 0.20 delta call option in the front month: SELL (1) SPY 28 APRIL $419 CALL @ 1.17 BUY (1) SPY 19 MAY $419 CALL @ $4.19 Net Debit: $3.02 Notice how the payoff of the trade dramatically shifts, while still maintaining the same cone shape: The blue dotted vertical line is the underlying spot price. Notice how the underlying stock needs to go up for the trade to make money, but not increase too much that your front-month option expires with intrinsic value. You’ll notice that regardless of which strike price you pick, whether it’s in-the-money, out-of-the-money, or at-the-money, you’re still aiming for the stock to trade at or near the strike price when your front-month option expires. Defined Risk Profile You can’t lose more than your net debit in a calendar spread. Even though you’re short an option, its P&L is offset by owning a longer-dated option at the same strike price. Limited Profit Potential While the calendar spread offers a limited risk profile, it also comes with limited profit potential. Because you’re long and short calls at the same strike price, any upside in your long call will be offset by your short call. It’s difficult to pinpoint exactly what the maximum profit of a calendar spread will be because it depends on the changes in implied volatility between the two expiration dates. Net Long Premium (Net Debit) The calendar spread operates as a net debit options strategy, meaning you pay a premium to enter the position. In other words, it means you’re net-long options. This can be a point of confusion for the calendar spread. After all, the majority of theta decay strategies collect a net credit. But remember, between two options with the same strike price, the option with more time value will always cost more. Because we’re selling a short-dated option and buying a longer-term option, the calendar spread will always incur a net debit. The net debit represents the maximum you can lose in the calendar spread. The Calendar Spread is Vega Positive A positive vega trade is the same as being “long volatility,” they’re just different ways to say the same thing. Because the calendar spread is a net debit strategy, it profits from increases in implied volatility (IV). This is because longer-dated options have more vega, so any losses as a result of increases in implied volatility will be more than offset by gains in your long-dated options. However, this can work against you. If the increase in volatility is the result of a breakout or the start of a new trend, it can often mean that the price is moving up or down too much for your trade to be profitable at the expiration date. Remember, while calendar spreads are positive vega, ideally the stock trades around the strike price as the value of the front-month option slowly declines as a result of theta decay. Calendar Spread Structure: How to Create a Calendar Spread The core concept of a calendar spread involves selling a short-term option and buying a longer-dated option at the same strike price. There’s a number of considerations involved when structuring a calendar spread. The most important comes down to your market view. Your opinion on what you think the market will do should drive which strike prices you choose, not the price of the spread. The Choice of Strike Price: Calendar Spread Examples You can boil down the choice of which strike price to use in a calendar spread to three basic types of calendar spreads: In-the-money (ITM) calendar spreads At-the-money (ATM) calendar spreads Out-of-the-money (OTM) calendar spreads These differences shape the payoff profile of the trade, as well as the cost of entering the trade. In-the-Money Calendar Spread Example An in-the-money (ITM) calendar spread uses ITM options. For instance, if the underlying stock is trading at $410, you might use the $400 calls or $420 puts. While ITM options on their own are expensive, ITM calendar spreads can be quite cheap compared to its ATM and OTM counterparts because ITM options have comparatively low extrinsic value, narrowing the difference between the short-dated and long-dated options. As a result of the lower price tag, the maximum profit of an ITM calendar spread is also lower than OTM and ATM spreads. Let’s take a quick look at one: SELL (1) SPY 28 APRIL $400 CALL @ 15.25 BUY (1) SPY 19 MAY $400 CALL @ $18.90 Net Debit: $3.65 Here’s the payoff diagram. Keep in mind that the blue dotted vertical line represents the underlying stock spot price: At-the-Money Calendar Spread Example At-the-money (ATM) calendar spreads are the most expensive type of calendar spread to enter, in terms of the net debit you have to pay to put the trade on. They're also the calendar spreads which have the smallest maximum profit level. Let’s take a look at an example: SELL (1) SPY 28 APRIL $412 CALL @ 6.00 BUY (1) SPY 19 MAY $412 CALL @ 10.25 Net Debit: $4.25 Here’s a payoff diagram for this calendar spread: The blue dotted vertical line represents the underlying spot price. Notice how an at-the-money calendar spread reaches max profit if the underlying stock doesn’t move until the expiration date, resulting in the short-dated option expiring worthless. Out-of-the-Money Calendar Spread Example Out-of-the-money (OTM) calendar spreads require the market to move in your direction to make a profit. While calendar spreads are traditionally viewed as market-neutral plays on theta decay, you can also take a directional view by using OTM spreads. They also allow you to structure asymmetric reward/risk ratios. Let’s take a look at an example, with the underlying stock at $412.45: SELL (1) SPY 28 APRIL $430 CALL @ BUY (1) SPY 19 MAY $430 CALL @ Net Debit: $1.74 Here’s a payoff diagram: Expirations There are multiple things to consider when choosing the expiration dates to use in your calendar spread. Among them are: The implied volatility (IV) of the front-month should be high relative to history. You can use metrics like Implied Volatility Rank to measure this The implied volatility of the back-month should be low relative to history. The wider the gap between expiration dates, the higher your net debit will be, as you’ll be paying up for the time value of the significantly longer-dated option. The Choice of Puts vs. Calls When it comes to at-the-money calendar spreads, there’s not a big practical difference between using puts or calls. Due to volatility skew, put options will often have slightly higher implied volatilities, however, this effect isn’t significant enough to put too much consideration into. Calendar Spread Payoff and P&L Calendar Spread Maximum Profit Because you’re trading options in different expiration dates, it's not possible to precisely determine the maximum profit of a calendar spread. In other words, there’s no hard-and-fast rule to apply. The maximum profit differs from spread to spread. However, you can get a very good idea of how the P&L of the trade will evolve by simply looking at a payoff diagram of a calendar spread in your options trading platform. Many SteadyOptions users use OptionNet Explorer, ThinkOrSwim, and other tools from leading tools. For instance, let’s take a look at a simple ATM calendar spread in Apple (AAPL) stock: SELL (1) 19 May $165 Call @ $5.64 BUY (1) 16 June $165 Call @ 7.72 Net Debit: $2.10 Here’s a payoff diagram of this trade: This is one of the most “standard” calendar spread trades, which sells an option with roughly 30 days to expiration (DTE), and buys one with about 60 DTE. As you can see, the maximum profit estimated by ThinkOrSwim is roughly $300. This can slightly vary based on how the IVs of each expiration change throughout the trade, but it’s a very close estimate. Calendar Spread Maximum Loss/Risk The maximum risk of a calendar spread is the net debit paid to enter the trade. Let’s go back to the Apple (AAPL) example we used in the previous section: SELL (1) 19 May $165 Call @ $5.64 BUY (1) 16 June $165 Call @ 7.72 Net Debit: $2.10 To calculate the net debit (or credit) of an options trade, you simply calculate the price difference of the options you want to buy and sell. In this case, we’re buying an option for $7.72 and selling one for $5.64, making the difference and our net debit $2.10. This is our maximum risk on the trade. Calendar Spread Breakeven Prices Because we’re trading options with different expiration dates, there’s not a precise breakeven calculation. We’re trading the interaction between the two expiration dates, meaning we’re betting that the front-month expiration will theta decay faster than the back-month option. However, because the option Greeks of different expirations evolve over time, there’s no way to know for sure before entering the trade what our breakeven price will be. However, as said, the breakeven prices in an options trading platform are close enough. For instance, in our Apple trade from earlier, ThinkOrSwim gives us breakeven prices of $157.75 and $174.17. See the payoff diagram below: Calendar Spread Market View Why Matching Your Market View to Options Trade Structure is Crucial One thing we're trying to nail home in this reverse straddle primer is the importance of matching your market view to the correct options spread. As an options trader, you're a carpenter, and option spreads are your tools. If you need to tighten a screw, you won't use a hammer but a screwdriver. So before you add a new spread to your toolbox, it's crucial to understand the market view it expresses. One of the worst things you can do as an options trader is structure a trade that is out of harmony with your market outlook. This mismatch is often on display with novice traders. Perhaps a meme stock like GameStop went from $10 to $400 in a few weeks. You're confident the price will revert to some historical mean, and you want to use options to express this view. Novice traders frequently only have outright puts and calls in their toolbox. Hence, they will use the proverbial hammer to tighten a screw in this situation. In this hypothetical, a more experienced options trader might use a bear call spread, as it expresses a bearish directional view while also providing short-volatility exposure. But this trader can be infinitely creative with his trade structuring because he understands how to use options to express his market view appropriately. The nuances of his view might drive him to add skew to the spread, turn it into a ratio spread, and so on. What Market Outlook Does a Calendar Spread Express? More than anything, the calendar spread is bearish on short-term implied volatility. A trader using a calendar spread is essentially betting that the front-month or short-dated option that they sell short will expire worthless. The back-month long option essentially serves mostly as a hedge. Additional considerations Can I be assigned on my short options? If your short options become deep ITM, you can be assigned. If you have a call calendar spread, you will own the long calls and short the shares. If you have a put calendar spread, you will own the long puts and long the shares. In both cases, the long options will offset any gains or losses in the shares, so the final result would be similar to owning the calendar spread. Assignment by itself is not a bad thing - unless it causes a margin call and forced liquidation. Worst case scenario, the broker will liquidate the shares in pre-market, the stock will rise between the liquidation and the open and the puts will be worth less. Otherwise, you are 100% covered - each dollar you lose in the stock you gain in the options. You have two choices when it happens. First is just to let the short options to expire - since they are ITM, they will be exercised automatically, you will be short the shares and it will offset the long shares you were assigned. Second is just to sell the options and the stock at the same time. Both choices will produce a very similar result. You can ask the broker exercise the options as well, but this is like the first choice. When and how to adjust? Now, this is the key to successfully trading the calendar spreads. We will be very happy if the stock just continues trading near the strike price(s), but unfortunately, stocks don't always cooperate. You need to have a plan before you place the trade. Look at the P/L graph. Identify the breakeven points at the expiration date. This is where I usually adjust. The general idea is to keep the stock "under the tent". So if I started with a single calendar spread, I might open another one in the direction of the move. For example, if I opened the 145 calendar spread with the stock at 145, and the stock moved to 146, I might open the 147 calendar. This will double the original investment, so the alternative is to sell half of the 145 calendar and use the proceeds to buy the 147. If I started with a double calendar spread, I might open the third one. For example, if I opened the 144/146 when the stock was at 145 and the stock moved to 147, I might add the 148, instead of 144 or in addition. Again, the idea is to move the tent and to balance the delta. Directional or non-directional? At SteadyOptions, we trade non-directional trading. So in most cases, we will want to be as delta neutral as possible. If the stock moves up, the trade will become delta negative. To reduce the deltas, we will adjust as described. However, sometimes I'm okay to be slightly delta directional to balance my other positions. So if the stock moved up and the trade became delta negative, but I have some other positions which are delta positive, I might give it some more room and wait with the adjustment. Of course I don't want to wait too long, otherwise the loss might become larger than I would like to allow. Using OTM Directional Calendar Spreads provides a good explanation about directional calendar spreads. General rules/guidelines when trading calendar spreads Always check the P/L graph before placing the trade. You can use your broker tools or some free software. I usually use the Optiionnet Explorer software to generate the graph. Avoid trading through dividends date. Avoid trading through major news like earnings announcements. The only exception to that rule is when you want to take advantage of the inflated IV of the front month, but those are highly speculative trades which might have a significant loss if the stock has a large post-earnings move. The front month options should expire in 5-7 weeks - unless you use weeklys which is usually more aggressive trade due to the gamma risk mentioned above. Have an exit plan before you enter the trade. My profit target is typically 20-30% and my mental stop loss is around 15-20%. Trade stocks which are in a trading range. Most of the time calendar spreads work better when IV is low. Those are vega positive trades which means they benefit from increase in IV. Aim for a long option near the low of its IV range. This gives it room to rise. Avoid lower priced stocks - the trade will be too cheap and commissions consuming. As a rule of thumb, stocks under $50 usually are not suitable for calendar spreads. For example, if the trade costs $0.70, with $3 per spread round trip commissions the commissions will eat over 4% of the trade value, not including rolls. If the spread is $3, the commissions will be just 1%. Over time, it will make a huge difference. Pre Earnings calendars At SteadyOptions, one of our favorite strategies is pre-earnings calendars. This strategy takes advantage of special IV skew between long and short options. This strategy is among our most profitable strategies. We have used it with great success on stocks like GOOG, AMZN, NFLX, TSLA etc. Pre-earnings calendars (or double calendars) use short options expiring few days after earnings. The idea is that for some stocks, the short term options will lose value faster than the longer term options, causing the calendars to widen. For those stocks, the IV increase of the short options just cannot keep with the negative theta, and the options lose value despite IV spike. For example, GOOG short term straddles/strangles were consistent losers due to the accelerating theta, so we are basically short those options and long options expiring 1-3 weeks later. Bottom Line The calendar spread is a strategy that capitalizes on theta decay while hedging out the unlimited risk of shorting options. With the suitability to use either calls or puts and tweak strike prices to reflect a directional market view, you can tailor it to fit your specific market outlook. Related articles Why We Sell Our Calendars Before Earnings TSLA, LNKD, NFLX, GOOG: Thank You, See You Next Cycle Should You Add to A Losing Trade? Amazon Missed, And We Don't Care FANG Stocks Killed It. Again Using OTM Directional Calendar Spreads Want to learn more about the calendar spread strategy and other strategies that we implement for our SteadyOptions portfolio? Join now
  2. A typical set up is using calls and placing the spread at-the-money, but traders can also do directional calendars, and I’ll share a recent MSFT example below. One nice feature of calendar spreads is that the maximum loss is always known in advance. The trade can never lose more than the cost of entry or the debit paid. The maximum profit however, can be a little tricky and the best we can do is estimate it because we don’t know in advance how the back month option will be impacted by changes in implied volatility. When trading delta neutral calendars, you want to look for a stock with low implied volatility that you think will remain stable over the course of the trade. If I’m trading an at-the-money calendar, I set adjustment points around the breakeven lines. If the stock reaches either of these level, but hasn’t hit a stop loss, I will either reposition the calendar or turn it into a double calendar. Let’s take a look at a recent bullish calendar trade on Microsoft. On June 8th, the stock was trading around 188 and showing nice accumulation on the chart. My thesis was that it was likely to break above resistance at 190 and head up to around 195. As such, I entered a bullish call calendar at the 195 strike with 11 days to expiry. The total cost for the trade was $514 plus commissions and I set a profit target of 30% and a stop loss of 20%. Here are the details: Date: June 8, 2020 Stock Price: $188.20 Trade Set Up: Sell 2 MSFT June 19th, 195 calls @ $1.13 Buy 2 MSFT July 17th, 195 calls @ $3.70 Premium: $514 Net Debit Two days later, MSFT had rallied to 194.58 and the trade was up $245 or 47.67%. They don’t always work out this well, but this was a nice return on a small amount of capital at risk. One nice thing that happened with this trade is that the volatility in the back month rose from 25.5% to 29% which gave the trade a nice little boost. I recently put together detailed guides on calendars and double calendars if you want to learn more about these trading strategies. This was a short-term trade but some traders will also do what’s called a campaign calendar where they buy a six month call and sell multiple months’ worth of calls against it. Bearish put calendars are also a nice trade if you think a stock is going to drop or you want some general protection against a falling market. The beauty with put calendars is you gain due to the delta, but you also gain due to the rise in volatility. Of course, this could also go the other way if the stocks rises. A few quick tips if you’re thinking about getting started with calendar spreads: Stick with highly liquid underlying stocks and ETF’s. Stocks that have a tight bid-ask spread will be much better in the long run because you will be able to get better fill prices. Start with small trades and never risk more than you can afford to on any one trade. Position sizing should be no more than 2-5% of your account size. Happy trading and feel free to reach out if you have any questions. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. He likes to focus on short volatility strategies. Gavin has written 5 books on options trading, 3 of which were bestsellers. He launched Options Trading IQ in 2010 to teach people how to trade options and eliminate all the Bullsh*t that’s out there. You can follow Gavin on Twitter. Related articles How We Trade Calendar Spreads How We Lost 60% On SPX Calendar Why We Sell Our Calendars Before Earnings TSLA, LNKD, NFLX, GOOG: Thank You, See You Next Cycle Should You Add to A Losing Trade? SPX Calendar Spreads: Historical P&L Levels Using OTM Directional Calendar Spreads
  3. So if options are on average overpriced before earnings, why not to sell those options and hold the trade through earnings? There are few ways to sell options before earnings to take advantage of IV crash. One if through an Iron Condor. Many options sites do this strategy on a regular basis, based on high IV rank alone. I described here why selling options based on high IV rank alone might be not a smart move. The article described selling iron Condor on NFLX, based on the very high IV rank of NFLX options before earnings. Unfortunately, NFLX is one of the worst stocks to trade this strategy. While options on average tend to be overpriced before earnings, NFLX is one of the exceptions. In fact, it moves on average more after earnings than the options imply. So there is no statistical edge to sell NFLX options. The opposite is true - there might be a statistical edge to actually buy them and hold through earnings. Another strategy to take advantage of elevated IV is through a calendar spread, where you sell the near term options and buy longer term options. So when you buy options before earnings (via straddle or strangle) you want the stock to move. If it does, the gamma gains will outpace the IV crush. When you sell options before earnings (through calendar or Iron Condor), you want the stock to stay relatively close to the current price. In the straddle article, I described a TWTR trade from one of the options "gurus" that has lost 55%. The same guru recommended the following calendar spread before TXN earnings: Sell -25 TXN OctWk4 53 Call Buy 25 TXN Nov15 53 Call The rationale of the trade: Over the years, (TXN) has been one of my favorite earnings plays to trade. A very consistent winner, I have almost exclusively used a Neutral Calendar Spread on it, which is a strategy that takes advantage of over-priced options (high Implied Volatility) and time-decay. This strategy works best with stocks that have weekly options, and (TXN) has these available. Historically, (TXN) is just not a very volatile stock. Every rare so often, even when the stock has moved more than expected, the Neutral Calendar Spreads hold up extremely well. Last quarter, the stock had the following price movement after reporting earnings: Jul 23, 2015 49.84 51.26 49.59 50.51 13,271,800 50.17 Jul 22, 2015 48.30 49.64 48.00 49.30 15,381,500 48.97 This trade is priced great, so recommend getting in as soon as possible. 10/10. Fast forward to the next day after earnings: TXN gaped up 10%, and the calendar spread has lost 90%+. So much for "the Neutral Calendar Spreads hold up extremely well." The rational behind holding calendars through earnings is that IV of the short options will collapse much more than the IV of the long options, so the short options will lose much more than the long options and the spread will make money. While this is true, the calendar will make money from IV collapse only if the stock doesn't move much after earnings. The rule of thumb is: look at the "expected move" as measured by ATM straddle value before earnings. If the stock moves less than the expected move after earnings, the calendar will make money. If it moves more, the calendar will lose money. And if it move much more than expected, the calendar will lose a lot, because the time value of both options will be close to zero. And here lies the problem: even if you have a long term edge (buy straddle on stocks that move more than expected and buy calendar on stocks that move less than expected), from time to time those stocks will not behave "as expected, based on historical data", and the trades will be big losers. When this happens, there is nothing you can do to control the risk and minimize the loss. That said, it doesn't mean you cannot use one of those strategies and hold through earnings, assuming you use the right strategy for the right stocks. But you need to assume a 100% loss right front, be fully aware of the risk and use the correct position sizing. Those options "gurus" who fail to even mention the risks don't do their job properly. We invite you to join us and learn how we trade our options strategies in a less risky way. Join Us
  4. Michael C. Thomsett

    Ratio Calendar Spreads

    This works not only with calls, but also with puts. This is a straightforward, one-to-one form of the calendar spread, but it does not end there. This calendar spread is a popular strategy; it can be expanded, however, to create a ratio calendar spread. In this twist, you sell more of the shorter-term expirations and you buy fewer of the longer-term expirations. This makes it more likely that the short premium on the first set will pay for the cost of the long positions, due to the more rapid time decay of the faster expirations on the short side. Because you end up with more short than long positions, there is risk involved. The higher the ratio, the lower the risk. For example, selling two short options and buying one long is risky because the short side is one-half uncovered. But selling four short and buying three long is less risky, because of the greater degree of coverage. This can be seen as three covered positions and one naked, or overall as 75% coverage. A calendar spread is not as risky as it appears at first glance, even though one or more of the short positions are naked. This is true because time works in your favor. A few points to keep in mind: The short options are going to lose time value more rapidly than the long options. This means one or more may be closed at a profit, eliminating the uncovered option risk. Even if the short positions move in the money, they can still be closed at a profit if time decay outpaces intrinsic value. This occurs frequently, especially as expiration approaches. To avoid exercise, the uncovered portion of the ratio calendar spread can be rolled forward. The ratio calendar spread's risks can be managed by combining time decay with timing of entry (opening short positions when implied volatility is exceptionally high, for example). The most critical point about these strategies is that the short options are going to lose value before the long options, which gives you a great advantage. Even if one of the options is assigned early, the long positions can be used to satisfy that assignment. All or part of the short side can be closed at any time to eliminate the risk, making the ratio calendar spread a good strategy with less risk than you find in just selling uncovered positions. To avoid early exercise, stay away from short exposure for stocks whose ex-dividend date occurs before expiration, or where earnings will be announced while the positions are opened; an earnings surprise can also turn into a risk surprise for the ratio position. You add flexibility to a ratio calendar spread when you move beyond calls and look at the same strategy involving puts. If you believe, for example, that the underlying has strong support at or below a short strike level for puts, creating a put-based ratio calendar spread is yet another way to create profits. This strategy is especially effective for short-term trading programs. Swing traders can employ the ratio calendar spread using either calls or puts to create net credit entry with minimal risks and play both sides of the swing. This is far more effective than restricting the strategy to long options and enables traders to create profits while managing their risks. Risk cannot be overlooked or discounted, however. It is one of the great potential blind spots of options traders to overlook exactly how much risk might be involved in any strategy. How often does this occur? The strategy seemed foolproof when it was entered, but it ends up going south because the one event you did not anticipate is what happened. To manage the risk well, be aware of all possible outcomes. Don’t fall into the trap of only thinking about profit potential. Remember that loss potential holds equal weight. There certainly are ways to mitigate risk. For example, setting up a ratio with 75% coverage (4 to 3) instead of 50% (2 to 1), drastically reduces risk. Another way to reduce risk is to vary strikes and expirations. It is not necessary to limit yourself to one short strike/expiration and one long. The entire strategy can be set up as a box or butterfly with a ratio relationship, but this can get complicated, too. Some complex option strategies hedge loss to the point that the relatively small level of gain is not worth the need to monitor and control all the open positions. Risk is further controlled by taking profits when they develop. Too many option traders have been known to wait out a position in the belief that today’s profit will only grow in the future. But of course, it can also shrink or even disappear entirely. You end up having better results by taking profits, closing positions, and moving on to the next great strategy; you put those profits at risk when you hesitate, hoping for even more. As they say in poker, when you have a marginal hand, it is a mistake to get “pot committed,” meaning you have to put in more cash than you want to because you have already risked too much. The same wisdom applies to options. In fact, this could be the best insight to risk. Take profits when they are there, even if small. Equally important, take losses in the ratio position if it looks like timing was poor and the situation could get worse. Know when to fold, in other words. Gaining experience in poker could be a good starting point for improving performance as an option trader. Michael C. Thomsett is a widely published author with over 90 business and investing books, including the best-selling Getting Started in Options, now out in its 10th edition with the revised title Options. He also wrote the recently released The Mathematics of Options. Thomsett is a frequent speaker at trade shows and blogs on Seeking Alpha, LinkedIn, Twitter and Facebook. Related articles: How We Trade Calendar Spreads SPX Calendar Spreads: Historical P&L Levels Using OTM Directional Calendar Spreads
  5. Study Methodology Here are the specifics of the test: Time Period: January 2007 to Present Trade Setup: On each trading day, locate the standard expiration cycle with 30-45 days to expiration. If the front-month standard expiration cycle did not fall within that time frame, we simply did nothing and proceeded to the next trading day. When the front-month expiration cycle fell between 30-45 days to expiration, we “sold” the at-the-money put in that cycle. In the following standard expiration cycle, we purchased the put at the same strike price to complete the calendar spread. Position Tracking: Each position’s profit/loss as a percentage of the debit paid was tracked on each trading day until the day before settlement. We did this to avoid any unwanted outcomes as a result of the SPX settlement process. Overall, 1,200 SPX calendars were tracked. Once all of the profit/loss metrics were gathered, we filtered the trades into four buckets based on the VIX Index level at the time of entering the trade: VIX Below 15 VIX Between 15 to 20 VIX Between 20 and 25 VIX Above 25 Each bucket had a similar number of occurrences. The Results: Profit/Loss Frequencies for 30-45 DTE SPX Calendar Spreads Let’s take a look at the data! We’ll start with the percentage of calendar spreads that reached profit levels between 10-100% of the initial debit paid: There are some key findings from these results: Over 50% of the trades reached returns of 40% or more on the initial debit paid, with 75% of the positions reaching 10-20% returns on the debit paid. The low IV (VIX below 15) and high IV (VIX above 25) had the highest percentage of trades that reached each profit level. High IV calendar spreads in second place? How can that be? In super high IV environments, the VIX term structure (SPX volatility) goes into backwardation. As a result, the near-term expiration cycles trade with significantly higher implied volatility than longer-term expiration cycles. When volatility comes back down, the front-month implied volatility will fall with greater magnitude than the back-month implied volatility, which can lead to quick profits on a calendar spread if the underlying hasn’t moved too much. The only problem is that in high implied volatility environments, realized volatility tends to be high, which is not ideal for delta-neutral calendar spreads. So, in high IV, long calendar spreads become more of a term structure reversion trade, and less of a time decay trade. Let’s move on to the loss frequencies: In low IV environments, the SPX calendar spreads reached each loss level less frequently than in higher IV environments. Again, this is most likely due to the fact that realized volatility tends to be more significant in times of high implied volatility. When you compare the calendar spread profit frequencies to the loss frequencies, we can see that the biggest gap (profit frequency – loss frequency) is typically in the low IV (VIX below 15) trades. For example, in the low IV bucket, over 85% of positions reached a 10% profit, while 65% reached a 10% loss. In the 15-20 VIX trades, 75% of trades reached a 10% profit, while 85% reached a 10% loss. Of course, you’d like to see a large gap between the percentage of trades that hit each profit and loss level (more trades reach the profit level as opposed to the loss level). To visualize this, we simply subtracted the loss frequency from the profit frequency at each level: As we can see, the calendars entered when the VIX was between 15 and 25 reached the loss levels more frequently than the same profit level (resulting in a negative value). In the low (VIX below 15) and high (VIX above 25) volatility environments, the SPX calendar spreads reached the profit levels more often than the same loss level. Summary What can we learn from this calendar spread profit and loss data? First and foremost, calendar spreads typically perform very well in extremely low implied volatility environments, but they also have potential when front-month IV is inflated at a significant premium to the back-month IV. However, there are strategies that may be more suitable for time when implied volatility is high. Second, based on a positive spread between profit and loss frequencies, calendar spreads have historically had positive expectancy at each profit/loss level, as profits have occurred more often than losses of the same magnitude. On a final note, it’s important to keep in mind that this is a backtest based on closing values. As a result, it’s likely that there were trades that hit profit or loss levels intraday, but ended the day less than those levels. Additionally, these positions were not managed, which is the key to success when trading calendar spreads. At the very least, the data discussed in this post can help to guide management levels, and expectations for achieving certain profit/loss levels when trading SPX calendars. About the Author Chris Butler is the founder of projectoption, an options trading education and research website. Chris primarily trades non-directional options strategies in equity indices (SPX, RUT, /ES Options), but is also active in volatility-related ETNs (VIX Options, VXX, XIV).
  6. Either puts or calls can be used, while puts are usually preferable to avoid dividend assignment risk. These are notoriously 'boring' (read profitable) trades and work well in low volatility environments on stocks that are not demonstrating much trend or find themselves in a consolidation phase. Since most traders use calendars as directionless trades, they are thought to lose value in trending markets. In this article, we'll challenge this view by expanding the use of calendars to directional, out-of-the-money (OTM) options trades and compare them against their more popular debit vertical spread cousin. An OTM Calendar has the same mechanics of the long calendar that we're used to except now we look to strike prices away from the current underlying price in order to express our directional assumption. We look to higher strikes with calls when we have a bullish assumption and we look to lower strikes with puts if we have a bearish bias. The price (and therefore maximum loss) of the calendar will decrease the further out of the money we go as well will the probability of touch (or profit). If we go out far enough we will see theta go from positive (typical in an at-the-money or ATM calendar) to negative (more typical of a long options position). The goal of the OTM Calendar trade remains the same as traditional ATM calendars - we're looking for the price of the underlying to be as close as possible to short and long strike shared in the calendar at the front-month's expiration. What's different is that we need price movement to get there versus prices standing still. What is most interesting, and the focus for the remaining of this article, is to compare the OTM Calendar spread against other directional options trading types.When looking for a directional options trade, most traders gravitate toward vertical debit spreads and therefore will be our basis of comparison. So, let’s look at 3 strikes (275, 280, 285) with an equivalent vertical and OTM call calendar spread on the SPY with a current price near $271/share at the time of writing: Strike Target Full Trade Short Name 275 VERTICAL SPY 10029 MAR 18 270/275 CALL @2.90 CALENDAR SPY 100 20 APR 18/29 MAR 18 275 CALL @1.50 270/275 Vertical 275 Calendar 280 VERTICAL SPY 100 29 MAR 18 275/280 CALL @1.60 CALENDAR SPY 100 20 APR 18/29 MAR 18 280 CALL @1.00 275/280 Vertical 280 Calendar 285 VERTICAL SPY 100 29 MAR 18 280/285 CALL @.65 CALENDAR SPY 100 20 APR 18/29 MAR 18 285 CALL @.55 280/285 Vertical 285 Calendar The Risk/Reward Profile: Debit Vertical Spreads vs. OTM Calendars Let’s first take a simple look at the risk/reward of these various positions and how they compare. Profitability Comparison – Verticals vs. OTM Calendars From the table above, we can make the conclusion that the OTM call calendars have a higher return on risk (ROR) vs. the call verticals with exception of the 285 OTM call calendar. This generally holds true in most market environments. We’ll come back to the behavior of the 285 OTM calendar shortly in a later discussion. Next we’ll compare the greeks across the various positions. Comparing the Greeks Between Call Debit Spreads and OTM Calendar Spreads Before we take a look at the greeksof our comparison positions, let’s review what we generally looking for in a bullish-directional options trade: Delta – We are looking for a high positive delta to match our bullish assumption. This allows us to maximize our profit with each $1 appreciation in the underlying stock. Gamma – We are looking for positive gamma to ensure our delta is becoming more positive as the trade moves in the correct direction. Theta – We are used to paying premium for the right to have a directional assumption, however, we always want as positive theta as possible (or less negative in long positions) so we pay less to hold the trade. Vega – We want a positive vega to ensure that if we have expanding volatility in the stock from drastic price movements that we capture some downside protection. Profitability & Greeks Comparison – Verticals vs. OTM Calendars Let’s look at the comparison between call verticals and OTM call calendars for each of the greeks. Delta The vertical spreads consistently created higher delta, which is great for our directional assumption. Vertical spreads will profit faster from price movements than the OTM calendars. There is a trade-off here in terms of the cost to hold the trade. We’ll discuss this in greater detail when we look at theta. +1 for Vertical Spreads. Gamma The vertical spreads also have a higher gamma. We can expect delta to become higher as the stock appreciates with the exception of the 270/275 Vertical which is already in the money. It’s very clear from looking at Delta and Gamma that, when compared to the OTM Calendar spreads, the verticals are much faster moving setups which allows us to profit more rapidly from sudden price moves in our favor. However, the opposite is also true where we lose money faster if the stock moves against our position. +1 for Vertical Spreads. Theta So far the vertical spreads are beating out the OTM Calendars, but this is where things finally get interesting. All of the vertical spreads have negative theta. I.e., we pay to hold the position each day, whether the underlying moves or not. The 275 Calendar and the 280 Calendar both have positive theta, which means we can expect to profit even if the stock stays stagnant and doesn’t move in our favor. This is impressive considering we maintain positive delta and a bullish assumption. The 285 Calendar is sufficiently out of the money that its theta has turned negative, but we still save 1.5 theta against the equivalent vertical position. We do pay for this luxury and this is where we finally circle back to the profitability evaluation. The 285 Calendar above has less ROR than the equivalent vertical position because we’re taking a tradeoff between less profitability and paying less per day as we wait for our price movements. +1 for Calendars Spreads. Vega This is where the calendar spread really shines. We see consistently higher vega in the Calendar Spreads vs. the Vertical Spreads. Any increase in implied volatility from actual price movement or from market news/speculation will benefit the calendar. In fact, if the underlying’s price moves away from our desired strike we’ll see downside protection so long as volatility expands with the price movement. It’s helpful to show a visual comparison here. The various colored lines in the charts below show 1% volatility steps in the SPY (4% total range). You can see how dramatically volatility affects the calendar vs. the vertical. In the charts below you’ll see that the calendars downside protection moves to $264.30 vs. $270.30 in the vertical spread. +1 for Calendar Spreads. Volatility Expansion Effect on Break-Even of Vertical Call Spreads Volatility Expansion Effect on Break-Even of OTM Calendar Spreads. The last thing that needs to be said about vega is its effect on profitability. Let’s look at the previous table but this time consider that volatility has expanded by 4% in the SPY. All OTM Call Calendars max profit increase with expanding volatility while the vertical spreads do not change. Volatility Expansion Effect on Profitability Comparison Between Verticals and OTM Calendards The chart below shows expanding volatility’s effect on the 280 OTM Call Calendar: Do OTM Calendar Spreads Beat Vertical Spreads? So we end up with 2 points for the vertical spreads and 2 points for the calendar spreads. This isn’t surprising – all trading consists of various trade-offs. We can trade delta for theta, gamma for vega, risk for reward. What we can conclude is that OTM Calendar Spreads provide a very interesting risk/reward profile and have dramatic benefits in the right environment. It’s up to you to scan for these opportunities. OTM Calendar Spread Management Assuming you see the merit in diversifying your directional options trading strategies with OTM Calendar Spreads, then let’s take a quick look a trade management rules-of-thumb. Here are five specific potential outcomes to think about for closing out and banking a profit (or learning from a loss): 1. Stock Moves in Your Desired Direction but Doesn't Hit the Target Strike An OTM put calendar is one with a strike price below the market price of the underlying asset while an OTM call is the opposite. If the stock moves slowly in your direction and the position has a positive theta, then you can afford to wait out the trade. This is the ideal behavior for these setups. When to get out? If you've made 25% of the max profit; once you achieve this rule-of-thumb checkpoint, exit the trade. 2. Stock Moves in Your Direction and Hits the Target Strike Be mindful of a situation where the price of the underlying approaches and reaches the position’s strike price. You want to be ready with a conditional closing order to get out of the position(s) if this becomes a reality, something most brokerage trading platforms permit. Set alerts as well as a reminder that this action should be taken immediately to avoid potential loss. Remember that calendars unlike vertical spreads will start to show negative delta as soon as the underlying passes the chosen strike. 3. When/If Volatility Expands Calendars benefit tremendously when volatility expands. If you are using OTM put calendars you will likely see double the benefit as falling prices are almost always coupled with expanding volatility. In this case, wait for your target strike to take off the trade. If you are using OTM call calendars then you need to be very mindful of expanding volatility. If volatility expands but you are seeing favorable price movement then you can consider taking off the trade. If volatility expands because the underlying’s price is falling, then you will see some cushion in your loss but you should consider taking off the trade. 4. When/If Volatility Contracts Contracting volatility is not a good environment for calendar spreads. This is why we almost always put on calendars (both ATM and OTM) when volatility is at the low end of the range. We look to measure such as IV Percentile and IV Rank to determine if the current volatility is relatively low or high. Despite best efforts to avoid contracting volatility with thorough evaluation of relative volatility at trade entry, it does happen time to time. When this happens it’s best to close the position. 5. If the Stock Moves in the Opposite Direction of OTM Calendar’s Strike. Continue to monitor and manage as you would a stock position. If you are using call OTM calendars, you will likely get a bit of a cushion with moves in the opposite direction because volatility usually expands with falling prices. Put OTM Calendars, however, often get hit twice as hard as the stock drifts away from the chosen strike price. Final Note: Consider Your Position Size at Entry. OTM Calendars allow you to spend a little to make a lot. Calendars are also debit spreads and you can never lose more than spent at trade entry. For this reason, keep your position size small enough (and manageable) so that it would have resembled the potential loss from where you would set your stop-loss on a stock-only position. Doing this allows you to sit back and just ride out the entire trade. The dynamics above can often reverse as well and turn a losing trade into a profitable one. In my own trading, I only use the 25% rule and just keep the positions very small. Conclusion – Should You Consider an OTM Calendar and When to Use them? All of this wonderful information begs a very fundamental question: should you consider an OTM Calendar and, more importantly (if yes), when do you use this setup? Here are four considerations to ponder that may make clear how useful an OTM Calendar is for you, taking into account the above points. When volatility is relatively low. This is particularly true compared to vertical contracts. When you're looking for time to work in your favor. When you have either a slight or major directional bias. In a voracious bull market, where premium selling opportunities are minimal. I hope you found this article interesting and valuable. Of course, I’m only scratching the surface of the subject so look forward to your questions and comments below. Drew Hilleshiem is the Co-Founder and CEO of OptionAutomator, an options trading technology startup offering a free options screener that leverages Multi-Criteria Decision Making (MCDM) algorithms to force-rank relevancy of daily options opportunities against user’s individual trading criteria. He is passionate to help close the gap between Wall Street and Main Street with both technology and blogging. You can follow Drew via @OptionAutomator on Twitter.
  7. Are You Ready For the Drawdowns? When thinking about big winners in the stock market, adversity and large drawdowns probably aren’t the first words that come to mind. We tend to put the final outcome (big long-term gains) on a pedestal and ignore the grit and moxie required to achieve that outcome. But moxie is the key to long-term investing success, for there is no such thing as a big long-term winner without enduring a big drawdown along the way… Amazon has gained 38,882% from its IPO in 1997, an annualized return of over 36%. To put that in perspective, a $100,000 investment in 1997 would be worth just under $39 million today. Breathtaking gains, but they were not realized without significant adversity. In December 1999, the initial $100,000 investment would have grown to $5.4 million. By September 2001, less than 2 years later, this $5.4 million would shrink down to $304,000, a 94% drawdown. It took over 8 years, until October 2009, for Amazon to finally recover from this drawdown to move to new highs. Just Bump In The Road? Most investors remember the last few earnings reports when the stock usually went up after earnings, but the picture was not always that rosy. Here is the history of AMZN reaction to earnings in the last 3 years (courtesy of As you can see, 2014 wasn't pretty. And it was a year when S&P 500 was up 13.6%. After today's report, AMZN investors have to ask themselves the following questions: Is it still a good buy? Is the current pullback just bump in the road or there is more downside ahead of us? Is the growth story over? Is the stock still reasonably priced at current levels? What if you decide to sell and the stock recovers nicely? Or maybe you buy and the stock continues lower? We Don't Care! Fortunately, as non-directional options traders, we don't really care. We just closed AMZN calendar spread today before the earnings for 30.0% gain. This was a non-directional trade based on Implied Volatility. Specifically, volatility skew that always exists between the front week and the more distant expiration. We have been implementing this strategy since 2013 with great success on stocks like AMZN, NFLX, GOOG, TSLA and more. Here are the results: Some of the advantages of this strategy: We don't care about the direction the stock goes. We don't care about fundamentals. We don't have to guess if the growth story is still intact. We don't need to time the market, "buy the dip" or "sell the strength". Instead, we can just relax and enjoy our gains, no matter what the stock does. Related Articles: How We Trade Calendar Spreads Can We Profit From Volatility Expansion into Earnings Why We Sell Our Calendars Before Earnings The Less Risky Way To Trade TSLA TSLA, LNKD, NFLX, GOOG: Thank You, See You Next Cycle Thank You FANG Stocks! If you want to learn more how to use our profitable strategies and increase your odds: Start Your Free Trial
  8. However, not all stocks are suitable for that strategy. Some stocks experience consistent pattern of losses when buying premium before earnings. For those stocks we are using some alternative strategies like calendars. In one of my previous articles I described a study done by tastytrade, claiming that buying premium before earnings does not work. Let's leave aside the fact that the study was severely flawed and skewed by buying "future ATM straddle" which simply doesn't make sense (see the article for full details). Today I want to talk about the stocks they used in the study: TSLA, LNKD, NFLX, AAPL, GOOG. Those stocks are among the worst candidates for a straddle option strategy. In fact, they are so bad that they became our best candidates for a calendar spread strategy (which is basically the opposite of a straddle strategy). Here are our results from trading those stocks in the recent cycles: TSLA: +28%, +31%, +37%, +26%, +26%, +23% LNKD: +30%, +5%, +40%, +33% NFLX: +10%, +20%, +30%, +16%, +30%, +32%, +18% GOOG: +33%, +33%, +50%, -7%, +26% You read this right: 21 winners, only one small loser. This cycle was no exception: all four trades were winners, with average gain of 25.2%. I'm not sure if tastytrade used those stocks on purpose to reach the conclusion they wanted to reach, but the fact remains. To do a reliable study, it is not enough to take a random list of stocks and reach a conclusion that a strategy doesn't work. At SteadyOptions we spend hundreds of hours of backtesting to find the best parameters for our trades: Which strategy is suitable for which stocks? When is the optimal time to enter? How to manage the position? When to take profits? The results speak for themselves. We booked 147% ROI in 2014 and 32% ROI so far in 2015. All results are based on real trades, not some kind of hypothetical or backtested random study. Related Articles: How We Trade Straddle Option Strategy How We Trade Calendar Spreads Buying Premium Prior to Earnings Can We Profit From Volatility Expansion into Earnings Long Straddle: A Guaranteed Win? Why We Sell Our Straddles Before Earnings The Less Risky Way To Trade TSLA If you want to learn more how to use our profitable strategies and increase your odds: Start Your Free Trial
  9. This year's sideways market has been very kind to calendar spread trades.We booked few very nice winners with SPX and RUT calendar spreads. When we opened another SPX calendar spread on August 5, I expected another nice winner. But the market had very different plans. The strike was 2100, which was right in the middle of the range for the big part of the year. Last Thursday, August 20 SPX was at 2061, and the trade was still in decent shape, down only 8%: However, as the selloff accelerated towards the end of the day, the trade was down around 20-25%. At this point I considered different adjustment options but didn't find an efficient and inexpensive hedge. So my plan was just to close the trade around 30% loss. I tested different adjustments and didn't find them too efficient, so considering the fact that we also had a butterfly trade that was expected to offset the loss, it was an acceptable result to me. However, SPX really collapsed at the last hour on Thursday, and the trade went through the stop loss in matter of minutes. I assume that most members wouldn't have time to act on the alert sent 5-10 minutes before the close. Spreads also became very wide, and I doubt we could close it anywhere near the mid. On Friday SPX gaped down another 20 points and the trade was down over 50%. By the end of the day the loss was 70%+. We used yesterday's rally to reduce the loss and closed the trade for 60% loss. To put things in perspective, SPX went down 130 points in 3 trading days. Last time it happened was 2011. So what could we do differently? In the wise words of one of our mentors, Dan Sheridan, "just buy a stinking put!" Dan survived on the floor of the CBOE trading options for over two decades, so he's experienced it. Lets see how things would be different with the put. When SPX went through our adjustment point, we could buy the 1750 put for just 0.75. This is how the P/L chart would look like with the put: As we can see, the chart looks much "smoother". But even more important, it significantly increases the vega, which helps in case SPX continues down and volatility increases. Fast forward to Friday morning: That's right. Instead of being down 50%+, we would be actually UP 41%. So what can we learn from this trade? The most important thing is "don't assume anything". Gaps happen and should be taken into consideration. If the market went down 60 points and became oversold, it doesn't mean it cannot go lower. Don't let your opinions impact your risk management. When in doubt, cut the loss or "just buy a stinking put!" This trade emphasizes once again the importance of position sizing. In our model portfolio, we recommend allocating 10% per trade. Which means that this trade had a 6% negative impact on the overall portfolio. Not pleasant but not catastrophic and allows us to leave another day. After closing 9 consecutive winners in August, we are still having a great month, while most major indexes are significantly down. Related posts: How We Made 23% on $QIHU Straddle in 4 Hours How Position Sizing Impacts Your Returns How we trade calendar spreads We invite you to join us and see how we manage our portfolio of non-directional strategies. Start Your Free Trial
  10. Well, those are stocks that we have been trading since 2003 using our unique Calendar Spread strategy. This strategy has been one of our best performers. We don't really care what the stock does, and we close the trade before earnings. The gains are usually based on volatility skew that exists before earnings and widens as we get closer to the announcement date. The last earnings cycle was no exception. This is how those trades performed in October 2016 cycle: FB - 37.2% gain AMZN - 30.0% gain NFLX - 26.3% gain GOOG - 57.9%, 37.3%, 45.8% and 21.6% gains (yes, we milked it 4 times in one cycle) Here are the results of those trades since we started trading them: Why we trade those non-directional strategies instead of just buying the stocks? Few reasons: We don't have to guess the direction the stock is moving. We don't have to study the fundamentals and to find out if it's still a good buy? In case of earnings miss (see AMZN case), we don't care if the current pullback is just bump in the road or there is more downside ahead of us. We don't care if the growth story is still intact or over. It was an excellent earnings season for us. We also booked 34% gain in TSLA, 19% on NKE and few more nice winners. Our model portfolio was up 22.9% in October alone, and up 80.1% since April. Some members did even better. Here is a testimonial from one of our members after we closed FB trade: This member joined SteadyOptions 3 years ago as a complete novice. He came a looooong way. This is where hard work, commitment and determination can bring you. At SteadyOptions we spend hundreds of hours of backtesting to find the best parameters for our trades: Which strategy is suitable for which stocks? When is the optimal time to enter? How to manage the position? When to take profits? Related Articles: How We Trade Straddle Option Strategy How We Trade Calendar Spreads Buying Premium Prior to Earnings Can We Profit From Volatility Expansion into Earnings Long Straddle: A Guaranteed Win? The Less Risky Way To Trade TSLA Amazon Missed, And We Don't Care If you want to learn more how to use our profitable strategies and increase your odds: Start Your Free Trial