Monday 11/9 Advanced Lab Notes

Advanced Trading Lab
w/ Tim Justice
11/9/09
Discussion Notes
Horizontal Put Calendar Spread


1. Philosophy

This is a time positive, volatility positive trade. It carries balanced delta that can skew either slightly positive or slightly negative due to the strike price selection. You can use any stock or etf that has options, that is liquid, and that you are bullish on implied volatility for the stock. Stocks that will be releasing earnings in the next 2-6 weeks are good candidates. The direction of the stock does not need to be sideways but you can't believe it will aggressively trend outside your risk graph analysis.

2. Construction

A horizontal calendar spread is a simultaneous purchase of one longer term option while selling a shorter term option at the same strike price. Sell an option 1-2 months out in time, and buy the option 2-8 months out in time. The option you sell must be worth .50 cents or more. The total debit in the trade must be worth 1.00 or more. The option you sell can only be the front month if that gives you enough time to execute your trade. If front month expiration is in 4 days...you won't have enough time for IV to work on the option. Decide on a position sizing rule for your account. Keep each calendar spread roughly the same size from trade to trade.

3. Trade Management

First, exit the trade if it ever moves outside your breakeven points on the risk graph. Once you get some experience with the model you can adjust that risk control rule. Also, use a risk graph, factor in time (3 weeks) and volatility to set a target order. Do NOT hold through earnings. If IV gets crushed and is at a low you can also look to take profits.


Example

We found 4 stocks that release earnings during the week of the 23rd-25th (2 weeks out).

www.earnings.com

DE
HPQ
MDT
TIF


We settled on HPQ because that was the only one we looked at ~ :)

HPQ has earnings in 2 weeks. We sold -1 Dec 50 Put and Bought +1 Feb 50 Put. The total cost is 1.22. We would look for about .20 cents of gain after 2 weeks of time passing.