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Tales of a Technician: Forsake Verticals, Embrace Calendars

March 24, 2016

By | 10 Comments


Alright ladies and gents. Time for an educational strategy walk through. In light of the volatility swoon mentioned in my last post, attractive credit trades have been hard to come by. And that’s a bummer for traders who were looking to fade the overbought market with bear call spreads. The lack of premium is making the already lopsided risk-reward even worse. That is, option sellers are taking lots of risk for just a wee bit of profit.

What to do, what to do?

Harness the power of calendar spreads. A put calendar should do the trick. It’s a debit trade and thus capitalizes on the sale going on in options land. Plus we can position it to profit if the much needed pullback in this overheated market finally materializes.

The gist of the put calendar (aka the put horizontal spread) is to buy a 2 month option while selling a 1 month option (or thereabouts) of the same strike price. The strike selected serves as your target, the price level you hope the stock reaches in the near future. And since we’re thinking the market could drop a bit we’re going to use OTM puts to set this puppy up.

The position starts out delta negative which allows you to rack up profits during the downturn. It’s also positive theta providing profits as time passes. Finally, it’s a long volatility play. A rise in implied volatility aids the trade which is appropriate for the current market given the low volatility levels greeting investors this week.

I’m using Wednesday’s closing prices to illustrate this. In deciding which strike price to use let’s assume we think SPY might retrace to $198 sometime over the next month. To structure the trade simply buy to open the May 198 put while selling to open the April 198 put. Let’s say we buy the May 198 put for $2.98 while selling the April put for $1.13 for a net debit of $1.85.

SPY chart

The max loss is limited to the initial $1.85 debit. The lower the volatility the cheaper the options. The cheaper the options the lower the cost of the trade. And, finally, the lower the cost of the trade the less risk involved. That’s why put horizontals become mighty attractive in a low VIX environment.

Check out the risk graph of the position below.

SPY risk graph

To more accurately estimate the potential profit if SPY ends up dropping to our target ($198) we can move the date forward a few weeks into the future. Let’s assume SPY falls to $198 on April 1st. Per the risk graph the price drop coupled with the time decay will deliver a $53 gain, or roughly a 30% return on investment. And that’s not accounting for any type of implied volatility increase that may kick-in along the way. If we get a decent volatility ramp the profit will be even higher.

And if more time passes and SPY is sitting at $198 on April 5th or April 10th, or whatever, your profit will be higher as well.

So there you have it folks. An interesting alternative to bear call spreads when volatility is low and a price drop is expected.

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10 Replies to “Tales of a Technician: Forsake Verticals, Embrace Calendars”

  1. Awesome article! Love it.

  2. Nicholas Kingsbury Nicholas Kingsbury says:

    Love it. I actually sometimes on low IV stocks will string two calendar spreads together, say one in the money and one out. When you put that on the risk graph it creates kind of a bowl of a max profit zone. I do this I am not the worlds greatest chart reader and it gives me more room for error. (Noah’s stock report really helps though!)

  3. Kody Potter Kody Potter says:

    Thanks Tyler! Looking forward to your newsletters on spreads!

  4. Nicholas Kingsbury Nicholas Kingsbury says:


    Still working on the rules for the strategy, sometimes it works great, sometimes not so much.

    Here is what I got so far.
    Low IV and High volume.
    Place two calendars, one in the money and one out.
    Then using the risk graph it creates a bowl, I place the slices to break even and expiration, then hit the probability analysis tab, and make sure the probability of the price staying in that range is greater than 40%.
    I will normally adjust the strike prices till I like the range and shape of the bowl.

    Stop loss- break even at expiration.
    Profit taking- If I receive more than 10% of my Net liquid, I check the risk graph, and if the price is near the edge of the bowl at expiration, I take the profit and reset the trade. If the price is near the center of the bowl I let it ride longer.

    Like I said am still working on the rules and have a ton of these going on paper trades. If anybody sees any major flaws or has any thoughts on this feel free to comment. Like most of you readers, I greatly enjoy opportunities to learn.

  5. Thomas Hammonds Thomas Hammonds says:

    Thanks Ty. Interesting Nicholas. I will try that too.


    Thanks, Tyler. Gotta go sim this in paper.

  7. FrancesK FrancesK says:

    Sounds like a great trade for now — thanks!

  8. Avatar Paul Seward says:

    Thanks Tyler,
    I can do verticals and CC’s with my eyes closed. Learned the calendar in my classes, but haven’t put them to work yet. Time to master a new game!

  9. Avatar Paul Seward says:

    Tyler, I’ve been playing with this. If I do a call calendar, I get essentially the same risk graph as a put calendar for the same strikes and months. What’s the difference?

  10. Paul, did the synthetics article answer your question? https://tackletrading.com/synthetics-this-that/

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