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Options Strategy: Calendar Spread (Setting Up the Calendar)

March 11th, 2014

Hey its Sasha Evdakov founder of Rise2learn and in this video I want share with you how to trade options no one to talk about what exactly is a calendar spread.

This is just an overview so it's not going to get in detail about calendar spreads but i just want to give you an overview insight of what a calendar spread is.

First of what you're doing with the calendar spread is you’re buying premium in one month as protection in your selling premium in the current month so that's why it's called the calendar spread so your nearest month what you're doing is you’re selling the most amount that you can and in the further away month you're buying protection.

calendar-spread-options.0029

Now typically the options deteriorate and the one in the current month deteriorate a lot faster than the 1 in the later months and that's what you're trying to do is you're trying to gain that premium and reaping the benefits behind that premium.

That means that your stock doesn't really have to move for you to make money because you can capture gains and returns from a stock not moving or going anywhere.

Here we have a calendar spread profit picture and if you take a look at this and you know what a butterfly looks like it looks similar to the butterfly now there are a few differences behind the calendar spread but as you can see if you buy this calendar spread at the sixty dollar mark which would be right in the middle then you would be making a profit if the stock doesn't go anywhere between about fifty five dollars and sixty-five dollars.

Now you can also position this calendar to the right for a more bullish sentiment or to the left for a little bit more bearish sentiment if you have idea of where the stock is going in direction or if you want to offset risk in some way.

You don't have to put it on a right in the middle to capture the gains or theta but remember the goal behind these types of trade is that their multi-dimensional that means you make money in two different ways. You make money for one by the deterioration of the premium in your earlier month and you can also make money if the stock goes up or down depending on how you positioned the spread whether it's bullish or bearish

calendar-spread-options.0077

Whereas with just buying a stock you only make money if it goes up you wouldn’t make money from the premium deterioration kind of like an insurance company would. Looking to set up a calendar spread one thing you want to watch is at these days to expiration so what we would do is buy one at 78 days away and sell one at fifty days away because option contracts deteriorate quicker the closer they are to their expiration date so the 22-day would expire even faster.

Now looking at Facebook here you can see the volatility skew over in this right area or what you can do is take a look at the implied volatility here for that specific contract now here you can see the April ones are 42.28 percent with a plus or minus eight-percent and the May ones are 49.5 percent so here we have actually a negative skew for volatility 42 -49 is actually about a negative 7.

Now with this -7 is not usually good because what that means is you're going to be selling something for cheap and buying protection something that’s more expensive so the protections going to be expensive for you to buy and what happens there is that volatility can screw you over and that's what happens with options you lose money where the things that can affect it is the price in the volatility.

If it moves against you or the volatility jump so it’s actually two main risks. Instead what we would rather do is find something that's two points on plus or minus on the skew not something like 7, 10 or 15 points.

Now if you look at CMG on this example on this day you can see this actually has a thirty three and this one is a thirty.

You can see that this is actually better because you have a positive skew 33 -30 you're buying protection cheap and you're selling something that’s expensive so that would be a better route to take but I'm going to show it to you on an index option because you can still do it really even if it's more expensive.

It's just that it can burn you a little bit and if you're losing out on options and training options and you don't know what's happening it’s the volatility you know it's not the price it's the volatility that's hurting you and you need to learn more about volatility.

Here on the index options what we can do is if we want to do a calendar spread what we would do on the Spy is first we have to sell one single and we can analyze that duplicate trade add it to our position and then the other thing we would have to do is we have to buy one for protection.

calendar-spread-options.0104

Here we did the 186 so we would have to buy a single for protection and we'd analyze that duplicate trade so this is the profit picture that we would get this is our calendar spread I added five contracts to it were selling one in the April and we're buying protection in the May and you can see it’s a little more positive.

Now what happens with this is we have a positive data here a 1.63 so that means that every single day as I move the date forward we make a 1.63 and as the stock doesn't do anything that Theta keeps increasing per day meaning the dollars are making per day keeps increasing because as we get closer to expiration you make more and more money since the option deteriorates quicker.

As you can see that we make the most money if we're right here in the center of this profit picture but it doesn't always work out that way. So understand when you're putting these on. Let's say you put on five contracts you might take a few off one or two as its standing or not doing anything.

What you can also do is put this at the 87 mark and this one as well you have to change it and make it a little more bullish you know you can make it a bullish calendar so that way if the stock doesn't move or do anything you would still collect two hundred and sixty dollars are so you can see it here as on the profit picture.

You would collect two hundred sixty dollars and it can also move up so you have a lot of upside safety but some downside risk.

You can also change this to be a little bit more bearish so if we did the 182 the same thing so here this one is a little bit more bearish are a lot more bearish and this one as we go to the downside we make money or if option stays still or the contracts stay still then we also make money from deterioration. N

Now we don't make the most amount of money if it standstill you know we're kind of breaking even but we can still make fifty to sixty bucks in a week and from the deterioration and of course you can move your contracts up if you want then trade larger but I wouldn't do that to start with.

Now if you wanted to enter this position in one single order all you have to do is right click by a calendar click it, it pops up as one single order and this is usually the best way to go about it because you get the best fill prices and the best rates.

Looking at it here you can see we entered it as one order and again I can play with this area and let's say I want it more in the middle I can do 185 if I want it a little bit more to the upside you know I can do it at the 187.

calendar-spread-options.0130

Now the volatility and the Vega is the thing that can hurt you here so if we change it here with the volatility as it goes down you can see what happens to this calendar it becomes very problematic.

Now on the other hand if the volatility goes up to the upside it helps you. So if you’re getting burned on the calendars this is the reason. Now one way like to counter act that is if I have a Vegaat around six I'll counteract it with a little bit of positive Delta.

If I was in a negative Vega position then I would lean a little bit short Delta so you always want to lean a little bit more Deltas with your Vegas so make it a little bit. It's not going to be exactly the same I wouldn't do it you know 7 and 7 I would do it according to kind of what the trade looks like because the problem is that volatility can hurt you but if the volatility goes up in this case with the calendar you’ll actually make money because see as I move the volatility up you're making money and volatility goes up when stocks drop.

That's why I would put this calendar on a little bit more positive and that's how I would position my risk aspects on these calendars and of course if you’re trading five calendar contracts you wouldn't just set them and forget them and wait for it to expire or hold it for 30 days. You might hold one for five days then see if the position holds and take some more profit as the calendar goes in your favor.

That's the way that you should trade is that taking money off the table learn to do that and take your profits.

Thanks again and remember to do what you love, contribute to others, and most importantly like abundantly.

Author: Sasha Evdakov

Sasha is the creator of the Tradersfly and Rise2Learn. He focuses on high-level education speaking at events, writing books, and publishing video courses on business development, internet marketing, finance, and personal growth.

I'm Sasha, an educational entrepreneur and a stock trader. In addition to running my own online businesses, I also enjoy trading stocks and helping the individual investor understand the stock market. Let me share with you some techniques & concepts that I used over the last 10+ years to give you that edge in the market. Learn More

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