SPY Calendar Trade & Discussion

One way to make money with options is through something called a calendar spread (also called a “time spread”). This is similar to doing a covered call strategy, only in this case you would buy a call with an expiration date that’s somewhere in the future to hold long (just like a stock). In the shorter term, then, you would sell a call with a nearer expiration date. (Or, if you’d bought a long put, you would sell a shorter-dated put against it.)

This is what’s known as doing a “long calendar spread.” We’ll touch upon the “short calendar” a little bit later. Today’s trade idea shows you how to establish a long calendar in the SPDR S&P 500(NYSE:SPY) – and not only will you get an options trade today, but also the logic behind setting it up this way.

There are a couple of keys to note here:

* Both option types must be the same (i.e., buying a put and selling a put in the same strategy, or buying and selling calls).

* You may have traded what are called “vertical” spreads in the past – options with the same expiration dates but with different strike prices. With the calendar spread, you have the “option” of trading the same strike price because you’re using different months. This can be helpful in making money with options without needing the stock to make a big movement.

Let’s take a closer look at an example, and then at a trade idea in the SPY, through this Q-and-A.

How can we play the SPY with an options calendar spread?
With SPY trading at $134, an example would be to “buy to open” 1 SPY April 134 Call at $4 and “sell to open” 1 SPY March 134 Call for $3. The cost of the spread would be $100 per contract ($4 – $3 = $1 x 100).

How do you make money?
On time decay, as we approach expiration and the SPY stays near $134, the March options will decay quicker than the April options.

Can we only make profits at the strike price?
No. In this example, your break-even points at expiration are around $130 and $138, so you can still make money even if the stock moves a bit away from that $134 strike.

How about if the stock moves too far?
One idea is to reposition the calendar. For example, if we move from $134 in this example to $130, we can take off the $134 calendar completely (i.e., sell the long April call and buy back the short March call) and put on a long call calendar at the $130 strike.

Would you put on a long call calendar at the $134 strike in SPY today?
No, but I would probably put on a long calendar at the $132 strike in the puts. An example would be to buy 1 April 132 Put and sell 1 March 132 Put.

Why would you put on the calendar at the $132 put strike?
With calendars, I want the stock to go to the strike price of the calendar. And right now, I’m slightly bearish.

What price would you pay for the April-March 132 put calendar?
It closed Friday at $1.40, so I would wait for an up day in the market and try to get it for $1.25.

Why would you wait for an up day to enter a bearish calendar?
Because the option volatilities would be lower and I like to enter these bearish calendars after a few up days, to get a better price.

How can you buy a calendar at $1.25 when it is trading at $1.40?
I have to be patient and wait for the stock to trade back up to around $135.40.

Once you buy the calendar at $1.25, what will you do if you’re wrong?
After I buy the calendar at $1.25  (if I do), then if SPY goes to $138 – although the SPY hasn’t hit $138 in years — then I might re-position the spread to $138.

Can you explain what you mean by “re-positioning the spread”?
Sure, if I’m wrong and SPY rallies up to $138, I will take off the $132 calendar completely and then enter a calendar spread at the $138 strike in the calls. An example would be to buy 1 April 138 Call and sell 1 March 138 Call after I close out the $132 spread.

This wraps up a frank discussion between Dan and himself on the calendar strategy in SPY Dan has his eyes on.

Today we talked about the long calendar strategy. There is also a short calendar strategy, where you’d instead buy a longer-dated option and sell a shorter-dated option. But that is considered to be unhedged and, therefore, your broker would be looking for you to put up a significant amount of margin.

So, the long calendar is lower-risk and may be a more-familiar strategy if you’re used to doing traditional vertical spreads and/or covered calls. Plus, you’re “hedged” here, which means the full amount you have at risk is what you pay for the spread. And your profit potential can be unlimited, particularly when the short option expires and not only is the credit yours to keep but you can also benefit from any additional movement that benefits the long (longer-dated) option.

Have a great day!

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