The one I came to that caught my attention was Calendar Spreads. I heard it was Tom Sosnoff's (from the Tasty Trade network) first trade.
Calendar spreads involve buying an option in a "back" month usually 40-70 days until expiration and selling an option in the "front" month usually 15 days until expiration. The point of a calendar spread is to take advantage of time (theta) decay which begins to exponentially take effect 15 days from expiration. Because the back month options are more expensive you will have a debit from your account and you are using the front month option to bring it's cost down.
The trade is usually put on during low volatility because you are essentially buying an option. You want volatility to increase so it will also increase the value of your option.
After doing some back testing I came up with a sweet spot that seems to work for max profit and max success.
- Implied volatility (IV Rank) of 12 or less
- 40-70 days til expiration for the back month
- 15 days til expiration for the front month
- 25% Probability in the money on the front month
- Exit the trade at 10-12% profit
- Exit the trade between 3-4 days or if negative hold closer to expiration for theta decay
- Trade liquid underlyings of at least 500,000 daily volume trades
- Trade underlyings that don't have wide moves
You have defined risk because you can not lose more than the cost of your investment. I tried my back tests on DIA and SPY and most of the trades were successful. The thing to keep in mind is that the trade is directional, meaning, your best chance of success is to make the right assumption at the direction of the underlying but what helps you out even if you are wrong in your assumption is if the underlying moves sideways after it moves. You make up any losses on the time decay feature of the trade. Of course the optimal situation is if the underlying moves in your direction, then you can take profits.
