My 1st Real $ Calendar Spreads: smart? dumb? opinions?...

Discussion in 'Options' started by gangof4, Aug 14, 2006.

  1. gangof4


    Looking for opinions as to whether these are sound trades, and which is the better in your opinion. Figure i'll post this b4 DE moves tomorrow, to avoid the skew of 20/20 hindsight! I've been researching calendars and, like with most strategies, my head spins like Linda Blair's, and i really only learn when i have real money at stake. so...

    DE reports earnings tomorrow. aug IV was pumped up to ~58, with sept. around 37. couldn't decide how to do it, stock was all over the place, so i did 2 varieties in different accounts. both are Debit non-directional:

    1. 70's

    STO aug 70 calls, BTO sept 70 calls
    STO aug 70 puts, BTO sept 70 puts:

    Total Debit of 2.55

    2. Strangle-ish

    STO aug 70 calls, BTO sept 70 calls
    STO aug 65 puts. BTO sept 65 puts

    TOtal Debit: 2.40

    exit strategy ( the word 'strategy' gives me too much credit!):

    obviously dictated by how much it moves. i took the positions because it seems a lot of ways to potentially win with all the theta that i'll get to pocket from the jacked up aug IV's. i tend to do OTM CDT strangles (trying something new), so, rightly or wrongly, my bias is towards the strangle-ish version.

    ok, don't hold back, let me have it!
  2. 1) PUT calendars and CALL calendars at the same strike are for most intents and purposes synthetically equivalent. Therefore, buying a PUT calendar and CALL calendar at same strike is the same as just buying 2 PUT calendars or 2 CALL calendars.

    2) Calendars are LONG VEGA as they are usually dominated by the back month option. Remember, vega is greater for options further away from expiration. After earnings, volatility comes in. It doesn't go up. However, the tenor skew (difference in volatilities across month's) may save you in this instance - perhaps that is what you were looking for. Generally, it is advised to be wary of calendars that are too cheap because there is normally a reason (front month IV is pumped up due to expected event e.g. earnings). Unfortunately, scanning tools often throw out these poor candidates. They are poor candidates because...

    3) Calendars are SHORT GAMMA. If there is a large move after earnings as is not uncommon, your calendar will lose value quickly and you will most likely realize a loss given proximity to expiration. DE has gapped after earnings before and a 5-10 point move in one direction is well within the realms of likelihood. Unfortunately, you only have 2-3 points either side of 70 for breakeven :eek:

    You will make money if there is very little movement in the underlying after reporting. If this was your forecast then so be it. It is not high probability and risk/reward is not great either. It's arguably nearly a candidate for the exact opposite trade: the short calendar. Fingers crossed.

    The double calendar (strangle variety) has a slightly larger "profit zone".

    Others will add...

  3. gangof4


    thanks for the thorough response- appreciated. yeah, i was attracted to the IV spike in the front month, coupled with the way the market has been trading, previous earnings moves in DE and an expectation of enough volatility over the next month.

    i preferred the strangle-esque version but, not being 100% clear, i figure doing both will be more educational (*hopefully* without a tuition fee!).

    i actually though to do the calendar when looking @ DE for a credit iron condor- previous earnings gaps scared me away and got me thinking. obviously little movement would be ideal.

    the other potential is that DE does what i've seen a lot of lately on earnings- stock goes a few % in one direction, only to head the other way later in the day or week. in that event, i'd close the OTM short and look for the stock to head the other way. even if not, theta will be gone from the august strikes soon enough. then, if left with the long straddle and/or strangle, it will be a question of how much volatility the market/DE see b4 sept. expiration. i tend to think it will see enough movement in some direction before 15 september.

    obviously dependant upon how i extricate myself from each side. if the net debit is palatable on the ITM side, i may end up turning it into a garden variety vertical. time will tell. will be interesting to see how i look back @ this trade/thread months from now. like i said, i don't learn well when no $ is @ stake...
  4. If your long leg is a few months out and you plan to roll the short a few times then would you be OK if the stock went up for the call version and vice versa for the puts? Even if they went ITM then you would get more premium on the new short when you roll.
  5. What about doing two diverging diagonals? This might even end up with giving you a credit on each side?
  6. jj90


    Danno, if you mean something like sell AUG 70s buy SEP 65P 75C, that's just the iron variety.
  7. Just saw this...

    Ignoring dividends, cost of carry, early exercise etc. they are the same.

    When you roll you are buying back your short front month and selling a back month option i.e you are selling a calendar spread.

    Whether your short option is ITM when you roll makes no difference. You don't get any more premium because of it. Any perceived extra premium from selling an ITM option in the back month is offset by having to buy back an ITM option in the front month and vice versa when looking at the OTM scenario.

    If you look at the risk profile of a calendar you will see that it is pretty much symmetrical around the strike price.

  8. That's why we newbies ask these dumb questions.

    Intuitively it seems like you are better off being ITM than OTM since the long side will be worth more. There are strategies where you buy far out ITM LEAPS and sell ATM options to pay for it. Wouldn't this be equivalent?

    Edit: After thinking about it, it wouldn't be equivalent, since you are kind of stuck with the original strike price of the calendar. I guess you could take a hit on rolling from ITM to ATM at some point.
  9. Yes, the long side will be worth more when it goes ITM but it doesn't move as fast as the short side i.e. the short side loses faster than the long gains because the short month has much higher GAMMA.

    The strategy you refer to is similar to a covered call but with the LEAP only at 50 deltas vs. stock or a DITM LEAP. The risk profile of a calendar like this with a long-dated back month option is not as symmetrical. It has a bullish bias whether using PUTs or CALLs.