My Ratio Calendar Combination on CLF

J

JJacksET4

I did one of these today - at least that (Ratio Calendar Combination) is what I'm calling it.

I have seen where the definition of "Ratio Calendar Combination" is selling more of the front month options, but I am buying more of the long month options. I can still call it this IMO, as it is a Combination using Ratios and different months.

Here is the trade I did:

Buy (2) Jul 60 Call - Filled at 512
Buy (2) Jul 50 Put - Filled at 442

Sell (1) Apr 60 Call -Filled at 239
Sell (1) Apr 50 Put -Filled at 187

Total cost = $1482

According to earnings.com, CLF next earnings is Apr 26-May 2 range, which would be after the Apr options expire. The current IV for CLF is around 55%, with 45 - 65 or so being the normal recent range.

The general hope is for an IV increase in the Jul options as earnings approaches. This trade appears to be slightly bullish, but of course has some potential to the downside as well. Also, in a substantial move downward, the IV would likely increase, which would help the position overall.

If possible, I may close a short Apr leg when one becomes cheap (under $50). Of course, if near Apr expiration and both sides are cheap, can probably just let them expire.

I have attached a P/L graph from OptionsXpress where it shows the P/L at short month expiration and also at Apr 1.

I will try to update this when there is a large change to the trade and/or possibly at the end of each week. If I continued to do more of these trades, maybe I will consider starting a journal with them, but for now this will just be this one trade.

Oh, one more thing:
Profit Goal - 15-25%
Consider closing at Apr expiration or as earnings approaches. If hold past earnings, risk large IV drop.

JJacksET4
 

Attachments

Over the years I've found that risk graphs are a little more optimistic than reality because of slippage. So I'd say that I'm not wild about this position.

I think that your analysis of the what ifs is correct but I'm not sure that you'll see a serious increase in July IV unless all months really bump up significantly. If not across the board, going into earning, the near month will have the greatest expansion followed by the second month which will be June (to be added at Apr exp), July might not see much.

I don't see any edge in the trade vis a vis the current IV of the respective legs. I'd want to see some horizontal skew to make it more worth the risk. If that existed, in the absence of a bullish bias (your trade), I'd unbalance the ratio to make it more neutral - that can't be done at a 2 contract level.

It's not a bad trade and it has the potential to be very profitable - just not enough for me for one of this type. Keep us posted and good luck.
 
Spin,

I think that is very good analysis overall.

On your first point, I have actually found OptionsXpress risk graphs to be slightly more pessimistic then for example the one from the Options Industry Council. I have seen some of these trades where the OX one shows say a $600 max loss, but using the exact same params, the OIC one only shows a $300 max loss. Anyways, that's something I have noted in my mind and is probably based on the exact IV params they are using, etc..

You make a good point about the IV increase not helping Jul as much, but then the time decay from now through Apr Exp would seem to hurt shorter months more, but then again they start cheaper..always a give and take.

Agree with the skew as well - it can be tough to find obvious skews of course where the overall IV then won't tank before the first Expiry - i.e. the First month IV can be high, but then usually an important earnings or something else will happen and then the IV falls off on the longer month.

I also agree with the balance part - this might work better as a short 3 strangles/long 6 calls/long 7 puts trade for example. Or I have even seen that per 3 of these trades, you can add 1 Put Butterfly for the short month centered around the max loss area of the trade at short expiration to reduce max loss areas to nearly nil.

Thanks for the comments,

JJacksET4
 
Quote from JJacksET4:

I have actually found OptionsXpress risk graphs to be slightly more pessimistic then for example the one from the Options Industry Council.

Regardless of what program you're using, it's a good idea to know your fudge factor, eg. approximately how much whatever charting tool you're using differs from actual results. IOW, add up the real time quaotes at a given price and compare that profit or loss to what the graph predicts it should be at that price.


You make a good point about the IV increase not helping Jul as much, but then the time decay from now through Apr Exp would seem to hurt shorter months more, but then again they start cheaper..always a give and take.

They're two separate issues. It's a given that Apr will decay faster than July. Since you bot twice as many long legs as short, you're net long delta and time decay is not your friend. Price rise and/or IV increase are. If July doesn't inflate, you need price to rise otherwise you're going to erode day after day.


I also agree with the balance part - this might work better as a short 3 strangles/long 6 calls/long 7 puts trade for example. Or I have even seen that per 3 of these trades, you can add 1 Put Butterfly for the short month centered around the max loss area of the trade at short expiration to reduce max loss areas to nearly nil.

Sometimes a single OTM long leg can be far more effective than a 3 legged critter like a butterfly. The add'l premium you pay for the outright long is more than offset by the slippage and commissions on up to 4 more legs (entry and exit) and isn't limited by the offsetting long/short legs. Plus it makes your head hurt less :)
More...
 
Quick update on this position, even though there has been nothing dramatic in it yet. I am using the numbers that OptionsXpress shows for and against me, which mostly seem to be in between bid/ask.

Long (2) Jul 60 Call - Value at 710
Long (2) Jul 50 Put - Value at 310

Short (1) Apr 60 Call -Filled at 381
Short (1) Apr 50 Put -Filled at 75

Long value = $2040
Short value = $456

Value = $1584.

There doesn't appear to have been any IV increase yet, so I will attribute the small gains so far to the price increase of the underlying.

JJacksET4
 
I've done trades like this in the past and as you pointed out, you want IV to increase. If IV decreases though, you'll really start to lose money.

I had a peek at the IV graph and it's been as low as 40 recently for this stock. Also, IV has been in a downtrend for a while.

Just be careful.
 
Quote from JJacksET4:


....
Short (1) Apr 60 Call -Filled at 381
Short (1) Apr 50 Put -Filled at 75
....
More...

Oops, should have said:
Short (1) Apr 60 Call - Value at 381
Short (1) Apr 50 Put - Value at 75

JJacksET4
 
I have not used these, but am interested in them. I am just starting to paper trade them, but usually not at a ratio of 1:2. Usually 2:3. These are more vega neutral. I wonder if you have experimented with different ratios.
 
Quote from drcha:

I have not used these, but am interested in them. I am just starting to paper trade them, but usually not at a ratio of 1:2. Usually 2:3. These are more vega neutral. I wonder if you have experimented with different ratios.
More...

drcha,

I can't say I have done a large amount of testing of using different ratios - of course, it makes sense if you do a 2/3 it would be more vega neutral, but I feel it may make profits more difficult on a large stock price move - personally, I like to have potential for large gains on a large stock move - of course, 2/3 will still do that, but not as much as 2/4 would in theory, so there is always a trade off.

One way I can look at this trade is there are potential profits if the stock goes up or down enough (even without IV increase), or if the stock stays near the middle for the short term (especially with IV increase). The main downside is a downward move with mild IV. I tried to set this up where I believe IV will be increasing as CLF approaches earnings, but of course I can't be certain of that.

I have found that many stocks have an IV that falls after earnings, but an IV runup towards earnings may not always happen, partly depending on the overall vol. of the market, and the price action in the stock.

I would be interested to learn anything that you have found doing these sorts of trades - also, how do you like to handle them (i.e. buy back the shorts when profitable?, close out the position at front month expiry?), or just what rules you try to go by. Or maybe you are just starting a set of rules for yourself to follow. I made a document of rules I have for this type of trade. Maybe I will review it and post it later.

Thanks for the interest,

JJacksET4
 
OK, Update again as CLF rose 4.03 to 64.34

Long (2) Jul 60 Call - Value at 960
Long (2) Jul 50 Put - Value at 230

Short (1) Apr 60 Call -Value at 659
Short (1) Apr 50 Put -Value at 45

Long value = $2380
Short value = $704

Value = $1676.

I paid $1497 for this position and a 15% gain would be $1722. I will go ahead and put a close on this position for a limit price of 17.00 and see what happens.

JJacksET4
 
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