Buy 1 GOOG April 28 835 Call and Sell 1 GOOG April 21 835 Call for $10.80 Debit with price at $834.43.
I just executed this order live at 1:17 pm central Chicago Time today, Monday. Why did I do this? Why would I pay 26 implied volatility for my long call and sell my short call at an 12 implied volatility? Because Earnings is coming next week and that will keep the April 28 Expiration Options high while the April 28 Options expiring this Friday will not be affected by next weeks earnings and the Implied Volatility should stay low or go down. How does this benefit me? For this Calendar Trade, I will have very little concern that I will lose money from Volatility decreasing and thus hurting the trade. Will I still have Price Risk? Absolutely. I paid $10.80 Debit or $1080 for this spread for every 1 contract. My goal would be to make 8-10 percent profit on my investment of $1080. So, I will have an order in immediately to sell out this Calendar for around $11.65 Credit for the rest of this week. That would be about an 8% profit on Capital used for this trade. If this spread trades around $9.60 or lower, I would get out and take my loss, around 10% on the Calendar cost of $1080. Obviously, if the spread is trading lower than the initial debit of 10.80 but hasn’t got to 9.60 yet, I could adjust or try to fix this trade by re-positioning the Calendar. This involves taking off the 1080 Calendar completely and entering a new Calendar at the strike closet to the current price of GOOG when you are making this adjustment.
Conclusion: This trade is a Calendar trade that tries to eliminate one of the two main foes of this strategy, Volatility, by buying an expiration affected by earnings and selling an expiration that expires before earnings. This strategy still has Price Risk, so we need to have a plan and exit the trade if the Debit of the Calendar decreases too much as the price of GOOG moves too far above the strike of 1040 or too far below the strike of 1040.
One of the most frequent questions I get from my mentoring students is how to calculate where to exit a trade for your profit goal. Some trades have margin while others don’t and some trades are debits and some are credits. This can all lead to confusion as to what a closing order should be.
Ignoring commissions for this example, if you have a trade that costs $250 debit and the margin is $1000 what would you want to sell it for to make 10%?-
The trade cost you $1250 so you need $125 ($1.25) more than you paid you make 10%. So $2.50 you paid + $1.25 is $3.75. $3.75 is your sell price for 10% profit.
If you have a trade that gives you a $250 credit and the margin is $1000, what would you want to sell it for to make 10%?-
$1000 in margin minus $250 target = $750 which is the cost of the trade. So you need to buy back this credit spread for $75 or .75 less than you paid for it. So if sold at a $2.50 credit, the closing target is $1.75.
You can simply add in your commissions to the cost of the trade and set your closing order appropriately. I hope this helps traders with this frequent question.
In Monday’s Blog, I talked about a Live GOOG Earnings Calendar I traded. I bought the April 28 Expiration 830 C and sold the Apr 21 Expiration 830 C for $9.55 Debit. GOOG was 828 when I executed the trade. Today, with GOOG around 823, $5 dollars lower, I sold out the spread for $10.05 Credit. That’s a 5.2 % yield in 2 Days! For every 1 contract, the profit was $50 on capital of $955, the initial debit. If you added in Commissions, our Community pays $ 1 per contract, the yield would be 46 divided by 955 = 4.8% yield (Commissions barely affected the yield). Will look to re-enter GOOG for another Earnings Calendar in tomorrow’s Blog.
Dan Sheridan ~ email@example.com