Calendar Spreads

I've been gone for a while trying to develop a strategy that fits my personality and temperament. I had studied so many differents strategies and I needed to simplify.

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.

Updated Trading Strategy

Here is my updated trading strategy:

• Trade high volume, high price stocks
• Look for the stock to be around the middle of its 52 week trading range
• High IV rank of 30% or better preferably 50% on up
• 90% probability of success and at least 1-2 standard deviations away
• Between 7 and 35 days left till expiration
• Leg into an iron condor with vertical spreads
• Collect at least .70 for each trade 
• Look to close each side at .15 one week later but no longer than 2 weeks later
• When the stock moves big one way look to close the winning side for a profit and re-deploy another iron condor
• Always stay at 90% probability OTM (out of the money) when you place your trade
• Never trade this strategy during earnings – use a different strategy 
• Use Person’s Pivots (PPS) to time entry
   

*Cash management

Leave $2000 available for options trading so you can fix any situations that go against you or jump on opportunities that may arise

Long Straddle and Strangles

I had an idea over the holidays to play one of the energy ETFs by watching to see if it will go higher or lower very quickly. I was late in taking this trade because I missed the opportunity when oil was going down really fast. But I now know how to play volatile markets more effectively. The strategy that I really like is the strangle option play. This is where you buy and out of the money put and an out of the money call. You are basically playing both sides of a trade.  One of the options will expire worthless while the other could potentially be a big winner. This will only happen if the stock moves quickly in one direction. Otherwise both options will expire worthless. So I call this my lottery play.  Instead of going to buy Powerball tickets I can buy options contracts when the market is really volatile.  This way I have the potential of making a lot of money very fast.  I will only allocate small amounts of money for these plays and I will only take them when I know the market is moving up and down erratically.

The straddle play is not as appealing to me because I don't want to lose large amounts of money for a risky bet. Both of these plays are betting that the market will move fast in one direction.  I would rather play the cheaper of the two. A straddle play is basically buying near the money or at the money options on either side and again hoping the market moves fast in either direction. with this play you are paying more money up front and of course you can potentially make more money but it is still a risky bet.

Market Conditions 9-29-14

Today’s market was crazy and I hope everyone has survived with some dignity left.  I have been revamping my strategy over the past couple weeks and haven’t been posting as much.  I fortunately got out of my Ford trade last week to initiate my new trading strategy.  As providence would have it, I got out just in time. 

I started to advocate selling covered calls for safe extra income but after I started learning how to sell cash secured puts and credit spreads, I no longer feel that covered calls are the best option trade.  The problem with covered calls and especially in a market that has become volatile, is that your money is tied up in a security that may lose value while you wait for the expiration of the option.  If you sell a cash secured put you keep your money safe in your account while you wait for expiration.

What happened to Ford today was a confirmation of that fact.  I had initially planned to hold Ford until the October 18^th expiration of one of my covered calls.  After learning about selling cash secured puts I liquidated my Ford position and started selling a few out of the money puts on some volatile bio tech stocks.  If I get assigned the shares at the end of expiration I will have bought the stock at an extreme low which is not a bad situation because the stock will most likely rebound.  If I am able to wait till expiration then I will keep the entire premium.

This is my new strategy now and I will provide more details as my trade develops.  In the meantime it is important in this market with its new found volatility, to keep as much cash as possible and to enter options trades without owning the underlying stock.  Credit spreads are probably the best plays in this market.

Selling Covered Calls For Extra Income

As the saying goes, “When you know better, you do better.”  I have changed up my strategy after watching what was going on with ARR.  I was a champion for this stock for months because I felt that it was eventually going to go back up to its $7-$9 price range.  Well you can’t wish something to happen, there has to be concrete steps and data to follow it up.  ARR never improved its financials and consequently the value of the stock stayed stagnant even when comparable stocks were rising. 

After a conversation with a friend of mine I realized that a safer and possibly more lucrative strategy would be better.  If you buy a well-known blue chip stock with sound financials that has enough volume, you can sell covered calls each month for steady income, much like the dividends I was seeking with ARR.  My own personal requirement was to find a stock that was trading below $20 so I could load up on it to have enough to buy at least 200 shares.  As you know (if you have traded options before) you have to have at least 100 shares to buy or sell 1 options contract.  To make the minimal return that I want to make I need to sell at least 2 options contracts.  The stock I chose was Ford (F).

Here is some more information on covered calls.  Many of the people and sites I’ve come across go into a lot of detail about covered calls but just know it’s not as complex as a lot of people make it seem.

Investopedia – Covered Calls

Trade King – Covered Calls

Alan Ellman - The Blue Collar Investor

Monthly Income From Covered Calls

If you look at the Bid price, that’s what you will be selling your call at.  Just remember that the Ask price is what you will be buying your call back at if you choose to buy it back (you will do this if you want to keep holding your shares and don’t want to be assigned at expiration).  To make any money you want the Ask price to keep getting lower so you can buy the options back for a price cheaper than you sold them for (buy low, sell high).  Either way if you sell a call at a strike price higher than the price you bought the stock (out of the money), then you have already made your money so you can just sit back and wait for expiration (always factor in fees and commissions).

Always buy the next month’s option because you want enough movement to occur in the time value of the stock.  Some people trade the weekly options.  I haven’t tried that yet but I may.

If you are new to covered calls, after you watch some of the videos and read some of the information on the links I posted, all of what I just said will make more sense and hopefully will simplify what you have learned.

Let me know how your trading goes by leaving a comment and if you have any other ideas I would love to hear them.