Earnings play -- short calendar spread

jimmyjazz said:
I am considering a short calendar spread as an earnings play (buy ATM near-term, sell ATM farther out). The underlying appears to be consolidating and a breakout seems likely.

I am never very comfortable trusting the PnL predictions I see on calendars, diagonals, etc. In this case, the predicted max loss is small compared to max gain, and the range in which the trade is a loser at front month expiry is small. Looks too good to be true.

Even if the predicted expiration PnL is optimistic, I am more concerned about the unexpected. What are the "failure modes" prior to expiry for these types of trades? How could I blow up, if at all? One problem I see is if both legs go deep OTM, I might not be able to find a reasonable market for either at front month expiration. I would then be proudly short the back month option, naked.

At this point I am leery to even put on a single contract pair until I know more about the risks involved. Thanks for any advice.
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You didn't provide vital info such as:
  • Stock
  • Option strikes
  • Option expiry
So I will use AAPL as an example. When real quotes are used the position can easily be visualized and everybody is on the same page.
  • AAPL at $126.81
  • Earnings April 27
  • Buy April17 126.00 Call at $1.82
  • Sell May15 125.00 Call at $5.35

Why would you be worried about both legs going deep OTM?

Also ...... Your first impression of a potential stock movement is most likely correct. In your case you expect a breakout - so I would base my option play around that and keep the position simple:

  • Buy Calls
  • Buy a Debit Spread
  • Sell a Put Credit Spread

If you over-analyze the situation you will find reasons not to make the trade.



:)
 
Looking at your example, I don't know why you would say AAPL is set to break out (presumably meaning break to the upside). Yeah, that's the trend direction, but in my view it could just as easily dump. So, the short calendar spread would be appropriate, except for my concerns about the back month volatility.
 
jimmyjazz said:
Looking at your example, I don't know why you would say AAPL is set to break out (presumably meaning break to the upside). Yeah, that's the trend direction, but in my view it could just as easily dump. So, the short calendar spread would be appropriate, except for my concerns about the back month volatility.
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The AAPL example is not a trade recommendation, or does it express my views on AAPL. It's purely for visual reference to a (long ATM near-term / short ATM farther out) position as you stated in your OP, and it addresses your concern about both legs ending up deep OTM.




:)
 
Well . . . OK? I'm not sure what you're trying to show. I'm still on board with the idea that a back month volatility explosion would possibly blow out my account, so it's a no go. I like sleeping at night.
 
jimmyjazz said:
Well . . . OK? I'm not sure what you're trying to show.
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To show your concern about a long ATM near-term / short ATM farther-out position ending up deep OTM is unwarranted. You should be able to buy-to-close the short options at a nice profit when the near-term options expire worthless.


jimmyjazz said:
I'm still on board with the idea that a back month volatility explosion would possibly blow out my account, so it's a no go.
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That would be an extremely rare black swan event.


jimmyjazz said:
I like sleeping at night.
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Then stick to option combos that expire at the same time and have clear risk/reward ratios.




:)
 
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