Calendar Spreads

Discussion in 'Options' started by OahuD, Jan 11, 2004.

  1. OahuD


    Greetings All,
    Just spent several hours reading the posts on this forum and decided to join.

    I've been trading covered calls for a few years and decided to try going long on QQQ calendar calls last Sept. Beginners luck to have started during a tremendous period for the Cubes! With my initial success I decided to hit the books (McMillan & Natenberg) b/c I know I just got lucky.

    Haven't plunked down the big bucks for Optionetics or OptionVue so I haven't been able to back-test various strategies for calendar calls.

    Mav, I know you prefer to short the far months, but since I'm trading in an IRA account, that's not an option for me. So I'd like to get some advice from you and others regarding buying DIA and QQQ calendar spreads.
    1. With a long spread, I'm good to go as long as the Cubes stay level or rise only a limited amount. I protect myself, somewhat, to the upside by selling only 7 or 8 near month calls for every 10 far month calls. I'm concerned about a moderate decrease in the Cubes. What are your thoughts on the pros/cons of buying/selling strangles versus straddles versus switching from calls to puts when the Cubes are trading below the 50 or 90 day SMA?

    2. With my current 7:10 ratio, I am wondering how to best protect myself (assuming I stick with calls) if there is a moderate to large sudden decrease in the Cubes. Buying puts would work (if I have enough of them) but them I have a wasting asset which is why I'm considering the strangle/straddle option in question 1. Your thoughts?

    I know there are plenty of other trades out there but I'm trying to get proficient with time spreads before I spread my wings any more.

    Thanks to any and all who reply.

  2. I look forward to Mav's reply but in the meantime, here goes:

    1) Keep 50% of your equity in cash. If you believe the long term trend is positive, then you leave yourself the ability to "double down" during (hopefully) short-term corrections (-5%).

    2) See number 1). Buying options as insurance is less useful than simply staying partially out of the market.
  3. Maverick74


    OK, first of all, for my short vol plays I prefer to trade wingspreads over short calendars. The reason I went through the short calendar spread on this forum was it was a safer and more conservative way to sell vega and more margin friendly then wingspreads.

    Now having said that, I'm not sure I understand exactly what you are asking here. Are you asking about using straddles on calendars vs just using calls and puts? I think in my examples I used straddles vs just calls and puts.

    As far as ratios go, why not just buy or sell stock to hedge the short gamma on the calendar?
  4. OahuD


    Maverick -
    Sorry for not being clear. I'm looking at several alternatives:

    1. Sell ATM Feb Call, Buy ATM Jan '05 Call. During downtrends I would switch to Puts.

    2. Sell ATM Feb Call, Sell ATM Feb Put, Buy ATM Jan '05 Call, Buy ATM Jan '05 Put

    3. Sell OTM Feb Call, Sell OTM Feb Put, Buy OTM Jan '05 Call, Sell OTM Jan '05 Put

    Option 1 requires me to correctly forecast whether the short term trend is up or down. I don't have much faith in my ability to do this. Also, I'm not protected if there is a big move the other way.

    Option 2 provides more positive theta since the calls/puts are ATM. However, Option 3 provides a wider range of profitability.

    What I'm looking for are pros/cons to each of the 3 options.

    Regarding buying/shorting the underlying, if I'm using Option 1 and have 50 contracts, wouldn't I need to short 5,000 shares to protect me if I wake up and the Cubes have plummeted from 38 to 30? If so, I'd be hurting real bad if the Cubes continued to shoot up to 48. What am I missing (besides years of experience)? This fear of a huge drop/surge is what has me leaning towards the calendar combo (Option 2 and 3 - what I referred to as straddles and strangles in my first post).

    Anyone backtested similar strategies for ETFs/Indexes going back to 99 to see the effect of a bear market followed by the recent bull market??


  5. Trajan


    What you are asking is difficult, the positions proposed require forecasting going out at least six weeks and up to a year. As far as 1 goes, you could sell stock if you were bearish, but 5000 would be way over doing it. An atm long calender would be more or less delta neutral(actually long deltas), selling small against it isn't out of the question. Selling a couple of hundred shares makes you delta neutral theoretically, it may make sense to short a little more than that.

    2 isn't that much differnt than 1. Often, time spreads make the most sense when there is a spike in IVs in either month, sell 55 and buy 35. The long time straddle spread is a good example of this, you want the Feb premium to crash and Jan to hold its bid. Assuming you get the 20 vol theoretical edge, the exit may take your profit. To make your money, it will take some trading savy, legging out or hedging and rolling out the next month.

    3, I've actually recommended something like this to my brother, of course his kids were yelling and screaming at the time so it may have just been revenge.

    As far as testing goes, the data for options is very expensive, if even available(I'm not sure if we ever determined this).
  6. OahuD


    Maverick and Trajan -
    Thanks for the replies. I'm aiming for a "slow and steady" return with reduced risk so after modeling various scenarios (using Peter Hoadley's software - great product for the price) I plan on using a diagonal calendar call spread, purchasing LEAPs rather than mid-term calls (Jan '05 36 calls instead of June '04 38 calls) and selling next-month out ATM calls (Feb '04 38 calls). Since this is in an IRA account I will buy a couple of OTM Put LEAPs, rather than short the cubes, to hedge my bets in case the market tanks.

    I welcome all comments.

  7. If you want to trade with the NASDAQ 100 as the underlying, I suggest using MNX options instead of QQQ options. Three reasons, two of which apply in your case:

    1) Much lower commission expense (as a percent of premium $) because 1 MNX = 4 QQQ. Thus the commissions are up to 75% less. If you trade in any size, this becomes material.

    2) MNX is cash settled while QQQ is stock settled; I find this more convenient at expiry.

    3) MNX receives 1256 tax treatment (60% long-term cap gains 40% short-term cap gains). This is very important if you are trading in a taxable account and you have a high marginal income tax rate.

    I also find on occasion that MNX has smaller b/a ask spreads because the QQQ spreads can't go less than a least until BOX gets going.