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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A Few Things You Should Know Before You Trade Options

BusinessmanOne of the questions that frequently comes up with option traders who have only done the equity side of options is how do I get into trading futures options and what do I need to know before I start?  There are several basic things you should know and understand about futures and their option before you get started with live trading of them.

What month should I trade?

One of the first characteristics to consider is that futures do not always have a new contract every month. Many futures, U. S. Treasury bonds for instance, have only a few contract months per year. Treasuries have March, June, September   and December only. All the months in between have options only that are traded derivative of the next futures month. Strategies, such as time spreads must be placed carefully to insure that you are trading off the same underlying contract month. Get to know your futures and options expiration periods before you start.  Not only the contract months differ from the equity world, trading hours do also so be sure to know when your underlying is being traded during the day and night.

What is the tick size?

Tick size for the different futures and options is different than many equities also. And the tick size of the options and the future itself can be different. Using the bond example again, the future tick size is $31.25 per tick and the options are $15.625 per tick. Futures trading can be larger and highly leveraged, it is important to understand how each tick movement is effecting your position.

What type of strategy should I trade?

Once you have a basic understanding of the future and its options you wish to trade you can begin to look at what strategies to employ.  Non-directional or directional strategies such as iron condors and calendars can be used but be careful with the time spreads that you are using the same underlying contract month as I mentioned earlier. From my own experience it seems iron condors either even on each side or sometimes weighted heavier on one side or the other can be a solid month-to-month trade.  Sometimes short or long straddles can be appropriate also.

Don’t trade without a PLAN!

Having a PLAN is the most important part of trading any underlying, whether you trade futures or equities. Before you enter any trade you should know and have a plan for how and when you will exit the trade at a profit or a loss and at what point you would adjust or reduce risk a trade that is going against you. In my experience mentoring new traders that is the most common mistake I see being made. You must also stick with your plan and try to control the emotions that would have you staying too long or not long enough in a trade. Your trading PLAN is fundamental.  Don’t trade anything without one.

If you follow these steps, you should have a good start to learning how to trade futures and futures options.  Trading always involves risk; learn to control it as best you can.

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Is it Treason to Short Apple?

It seems like Apple (NASDAQ:AAPL) has replaced the Dallas Cowboys as “America’s team.” And yes, I know it is a great stock – one that might actually be undervalued. But at the risk of sounding almost un-American, I think it’s time to start getting short AAPL.

Sure, the company just announced record – heck, downright mind-blowing – earnings thanks to iPhone 4S, iPad 2 and international sales. Even Wall Street analysts were impressed with the final numbers.

Unprecedented sales figures for the company aside, I’m a trader and, therefore, looking ahead to what the stock’s going to do next. With all the good news for the company, the stock has been climbing … but it can’t possibly go straight up without any down days.

In other words, even AAPL has to have a few days or weeks to act “human” … and you should get positioned to profit from the pullback when it comes.

As a trader, I am not concerned about AAPL long term. But here in the short- to intermediate-term, it’s quite reasonable and even wise to look for a little healthy downside trading action. Here’s a trade idea for the speculative part of my options portfolio.

Trade Idea: With AAPL trading here around $447, you can “buy to open” 1 April 430 Put (which would cost you about $12) and, at the same time, “sell to open” 1 April 410 Put (for which you would collect $7).

To enter this trade, which is a put debit spread (or a bear-put spread), your total cash outlay would be $5 per share, or $500 per option contract ($12 – $7 x 100).

You could simply buy the April 430 Put on its own, but by selling the $410 put against it, you instantly reduce the amount of money you would otherwise have at risk in the trade.

The spread is costing me $500 and the most I can make is $15 (the difference between the option strikes, or $430 – $410) if the stock is trading at $410 or lower at April expiration.

My total risk in a put debit (or bear-put) spread is the same as being long an option. Whatever I pay, which is $500 in this example, that’s the total risk. The cost of the spread at current prices is closer to $5.30, but I am going to be patient and let it come to me a bit. If the stock goes up a couple bucks from here, I should get filled.

Last week when I told you that it’s time to get a bit short, I also mentioned that you should enter your options trades by “nibbling,” or scaling in by buying your position in thirds.

Here, too, I am initiating this spread with 1/3 of my total intended position size. I am starting with one contract here and will work up to my total of three contracts as the stock increases.

Will I wait till April options expiration to get out of this? No way! Once we get a little pullback and the put spread gains some profits, I’ll head for the exits.

I’d like to make a minimum of $2 on this spread. By getting in at a good price, by scaling into the spread at less than my maximum size, and by using options with an April expiration date, I have lots of time to wait for a small pullback. That’s my plan and I’m sticking to it!

If, after I get up to three contracts and there is no pullback, I plan to show you in a future article how you can cut your total risk in half. (Hopefully, I won’t have to show you this adjustment as anything other than a strategy that’s good to know for future trades.)

Whatever happens, I will follow this trade to completion with you. Stay tuned to see if AAPL is really human. I’m betting it is!

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