Cooking Calendar Spreads

R

rocky_raccoon

I want to start trading calendars but there are several issues that hold me back. I am sure there are people on this board that have plenty of experience with calendars and I would like to get their advice on the following:

1. UL selection - I don't want to use individual stocks because of too much gap risk. This limits me to ETFs or indexes. I am thinking of SPY, QQQ, and IWM for the beginning. But which one is more appropriate?

2. Timing - Calendars perform better when IV of the UL is low. This would be now since we have fairly low IV for all three ETFs above. However, there was a VIX spike in the last several days. Should I wait for a lower VIX to initiate a position?

3. Bias (bull or bear) - I am thinking of initiating a slightly bearish position (e.g. 139 put spread on SPY). Any reason to move my strike closer to the spot price?

4. Front/back month selection - Sep/Oct or Sep/Nov? The latter would give me an opportunity to sell an extra Oct option. Is it worth the hassle or is it better to close one position and open another one near Sep expiration?

5. Exit strategy - does it make sense to exit after 10-15% gain that may happen within a first week or two or hold till (almost) expiration?

6. Maximum reasonable risk - The absolute risk of the strategy is the total debit paid however I plan the exit the trade earlier if it does not work out. Where should I place my stop order? Is 20% of the spread value enough or should I use a wider stop?

7. If I want to scale in and out of the position (1/3rd at a time), should I use the same strike or different depending on the UL move?

Thanks,
RR
 
Quote from rocky_raccoon:

I want to start trading calendars but there are several issues that hold me back. I am sure there are people on this board that have plenty of experience with calendars and I would like to get their advice on the following:

1. UL selection - I don't want to use individual stocks because of too much gap risk. This limits me to ETFs or indexes. I am thinking of SPY, QQQ, and IWM for the beginning. But which one is more appropriate?

2. Timing - Calendars perform better when IV of the UL is low. This would be now since we have fairly low IV for all three ETFs above. However, there was a VIX spike in the last several days. Should I wait for a lower VIX to initiate a position?

3. Bias (bull or bear) - I am thinking of initiating a slightly bearish position (e.g. 139 put spread on SPY). Any reason to move my strike closer to the spot price?

4. Front/back month selection - Sep/Oct or Sep/Nov? The latter would give me an opportunity to sell an extra Oct option. Is it worth the hassle or is it better to close one position and open another one near Sep expiration?

5. Exit strategy - does it make sense to exit after 10-15% gain that may happen within a first week or two or hold till (almost) expiration?

6. Maximum reasonable risk - The absolute risk of the strategy is the total debit paid however I plan the exit the trade earlier if it does not work out. Where should I place my stop order? Is 20% of the spread value enough or should I use a wider stop?

7. If I want to scale in and out of the position (1/3rd at a time), should I use the same strike or different depending on the UL move?

Thanks,
RR
More...

Calendars are a difficult trade because of the two different months but this would be a good time to do so if you are expecting an increase in volatility.

I don't trade these, I will add, so I don't know if I could be much help for you but since nobody replied, I will say that you will have to think a little bit out of the box in the construction of this trade. In other words, customize the strikes and don't be trading the front month, go a little further out, say OCT/MAR. Use the puts only and maybe sell around the 10-20 delta.

You will have to continuously manage this trade, keeping an eye on skews especially. This is a difficult trade but can be really good balance to your portfolio. I would try these on paper and like I said, don't put any standard calendar on. Set one up where you have +vega, +theta, -delta and that might help you get started. Close this if/when you get the big pop.
 
Quote from rocky_raccoon:

I want to start trading calendars but there are several issues that hold me back. I am sure there are people on this board that have plenty of experience with calendars and I would like to get their advice on the following:

1. UL selection - I don't want to use individual stocks because of too much gap risk. This limits me to ETFs or indexes. I am thinking of SPY, QQQ, and IWM for the beginning. But which one is more appropriate?

2. Timing - Calendars perform better when IV of the UL is low. This would be now since we have fairly low IV for all three ETFs above. However, there was a VIX spike in the last several days. Should I wait for a lower VIX to initiate a position?

3. Bias (bull or bear) - I am thinking of initiating a slightly bearish position (e.g. 139 put spread on SPY). Any reason to move my strike closer to the spot price?

4. Front/back month selection - Sep/Oct or Sep/Nov? The latter would give me an opportunity to sell an extra Oct option. Is it worth the hassle or is it better to close one position and open another one near Sep expiration?

5. Exit strategy - does it make sense to exit after 10-15% gain that may happen within a first week or two or hold till (almost) expiration?

6. Maximum reasonable risk - The absolute risk of the strategy is the total debit paid however I plan the exit the trade earlier if it does not work out. Where should I place my stop order? Is 20% of the spread value enough or should I use a wider stop?

7. If I want to scale in and out of the position (1/3rd at a time), should I use the same strike or different depending on the UL move?

Thanks,
RR
More...

Hi RR...have had some experience. Takes a lot of patience to manage and you have some well thought out points.

-The large index products are best..spy,spx, iwm, all good to go.
tough to get an edge in fill's.
-timing, vix isn't as low as it can go but is low enough. If your doing put calendars however and it (the vix) goes lower then it won't work as well. Obviously you want a slow moving UL.
-If you have a bearish bias then go a little otm...if your right you'll make money. If your neutral then closer is better.
-exit strats..well they take a great deal of patience and are best held to expiration(almost) unless your opinion changes and you decide to close them out. I wouldn't set a 20%...that can and does get hit so often you won't be able to turn much of a profit.
-risk is not necessarily just the debt...I've lost more than the initial debt when I mishandled the trade.
-definitely would NOT scale in or out. Each bet is pretty much stand alone defined risk trade. If you go out several months and roll into a different strike creating a diagonal then you raise the risk.

For me the downside to the calendar is the cost of comission due to all the rolling. Profits on calendars are very small and comish can eat up most of it. With the large index products you now have weeklies so you can roll every week. I haven't tried that but I do look at them occasionally just never seems to be a good trade.

GL

Oh and I definitely would NOT go out farther than 3 months..OCT/SEP or NOV/SEP...the world could come to an end after that. I have done 6 month calendars and those were the ones that crazy things happened and usually lost money.
 
Quote from hedgeman:

In other words, customize the strikes and don't be trading the front month, go a little further out, say OCT/MAR. Use the puts only and maybe sell around the 10-20 delta.

More...

Is this specifically to take advantage of the index skew? If you sell 10D-20D puts, what trade would you do on the back month? Do you hedge (how?) so you only bet on skew and IV?
 
Quote from kapw7:

Is this specifically to take advantage of the index skew? If you sell 10D-20D puts, what trade would you do on the back month? Do you hedge (how?) so you only bet on skew and IV?
More...

If I was looking at an OCT/MAR calendar, I'd make it a ratio set up. Selling at around the 10+ delta and buying less of the long further away from the money for the back month. The bet is on an increase in vol, I'm looking at RUT but needs constant management. I have one I just set up but again, this is not what I trade, just thinking out loud and analyzing. Set up is -delta, +vega, +theta. This is not an easy trade but if we got a nice move in vol, this is a winner.
 
Thank you for your answers. I see two contradicting ideas for time frame selection: SEP/OCT and OCT/MAR. For me it looks like the first one is better because it has higher theta and higher vega for an equal position size.

As for exit strategies, I saved an order on IWM 79 Sep/Oct Put calendar yesterday when it was trading @0.99/1.01 per spread. Today the same spread could be sold for 1.13/1.15. It's at least 13% in one day.
If I opened this position yesterday, would it make sense to sell it today for 13% gain instead of waiting longer?
 
Quote from RichardRimes:


-risk is not necessarily just the debt...I've lost more than the initial debt when I mishandled the trade.
More...

Could you please elaborate on this? How did you manage to lose more than the initial debit?
 
Its been awhile...but basically there are several ways. Go too far out like Mar/Sep and news hits that sends the stock up or down severly and you have to get out but either leg out and get screwed on the legs or because vols skyrocket the spread actually costs to close. Thats one reason to keep them near term. Remember earnings can and often skew things. So a longer term calendar you risk one or two earnings seasons.

IF I had kept my cool most likely I wouldn't have lost more than I put in...most often you do earn a small amount or lose a small amount.

The best way is do these sim for 3-6 months and you will answer most of your own questions.

from this old thread

http://www.elitetrader.com/vb/showthread.php?s=&threadid=58716

this is an excellent summation of calendar spreads


-05 08:01 PM

I stole a comment by Michael from the OptionClub Yahoo Group.

It's one approach to Calendars.

--- In OptionClub@yahoogroups.com, Michael Catolico
wrote:
>
> i look at calendars as a variation on a butterfly. they act much the
> same as flies in that the goal is to have the underlying expire as
close
> to the short strike as possible. however they are more complex since
by
> trading a calendar you are trading volatility.
>
> an ATM calendar is what i consider a schizophrenic trade. because you
> are short an ATM strike you want the underlying to basically do
nothing
> and sit still. but because you are long a back month strike you are
long
> vega. that means you want the stock to be volatile. if the stock dies
> your short premium comes in but so does your long premium. if the stock
> moves around, IV increases but the price movement can swing out of your
> ATM price zone. so you can therefore lose in two conflicting ways.
>
> that's why i prefer calendars in two circumstances 1) making cheap
> directional bets on near term events and 2) setting up a position
into a
> back month news event or earnings play.
>
> as a directional bet i look for situations where news is going to
happen
> in the front month. here usually there is a skew with front month IV
> higher than back month IV. when the news comes out there will be
certain
> IV crush across the board but hopefully the price movement will more
> than capture the vega loss. i analyze the play by assuming IV on the
> whole position will drop to slightly below the long term IV average and
> then look at my risk/ reward scenario.
>
> as an example look at CEPH which has earnings this week. the stock is
> trading around $45. i might take a bet that earnings will disappoint
and
> try a NOV/DEC 40 calendar. because earnings are happening soon NOV IV
> is skewed higher than DEC IV (49% vs. 40%). i can buy the calendar for
> about $0.30. long term IV averages about 35%. if i look at what the
> spread is worth if IV goes to say 30% i'd examine the value of the
> spread. if the stock is unchanged and IV drops to 30%, the spread will
> be worth about $0.20 by next week. if the stock drops to 40 the spread
> will be worth about $0.60. and of course if i'm wrong on direction and
> the stock gaps higher the trade is probably worthless. so given those
> three scenarios it's not too bad of a trade, especially if there is any
> reason to be especially bearish.
>
> for the second type of situation where i'll look at a calendar is when
> news is expected after front month expiration. since earnings season is
> basically winding down i don't have a good example for this. but
suppose
> a stock has earnings the week after NOV expiration. i might look
to do
> an ATM NOV/DEC calendar thinking that the stock might remain quiet
> through expiration. but with earnings coming shortly after, there's a
> good chance that the DEC IV will remain strong and perhaps increase. so
> by doing the spread now i put myself in a decent position to own that
> DEC option cheaply and then using that as an anchor leg for a spread
> going into actual earnings.
>
> in general i always try to match the expirations as closely as possible
> (e.g. i don't buy a LEAP and sell front month premium against it) since
> the correlation in IV gets weaker the farther apart the expirations
are.
> and generally i like to get calendars where i think i can at least
> double the value if held until the short expiration.
>
> michael
 
that part of the article at the end where he talks about shorting the expiration thats in front of the annoucement and being long the one behind sounds pretty interesting... vol inflates in your back month but the tides of theta kill the premium in the front month.. pretty good deal there..
 
Quote from rocky_raccoon:

Could you please elaborate on this? How did you manage to lose more than the initial debit?
More...
If you are delta-hedging, you can lose more then the premium differential. If you are "adjusting", you can obviously lose more too (grownup don't do that, but for some reason there is a myth floating around ET that you can "adjust" your way out of losses).
 
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