Option Trading Strategy: Trading as a Business Video 3 Part 16


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You can also see that Theta is positive, at 1.26. Even though you’re buying an option, you’re also selling one. Even though they’re at the exact same strike price, because they’re at different months, it gives you a positive Theta.

Also very interesting is, unlike a vertical spread that you would sell, it also gives you a positive Delta. That’s very important to understand.

Let’s go back here, for just a second. This is exactly what happens to an option, as time passes. You can see, on this scale, is the price of the option. On the horizontal scale, is the time period just prior to expiration. At right around 30 days to expiration, the value of that option drops down dramatically, as it gets closer to expiration.

The option becomes declining and decaying in value, as far out as 100 days. But the acceleration really takes place about 30 days to 40 days before expiration

That’s how we make our money. Those options are decreasing in time and value, the closer we get to expiration. That’s how we capture our profits.

Now, we can enter this as individual orders, but remember, just like a vertical spread, there is a danger in entering individual orders like this. One of them may get held, and the other one won’t. If that should happen, then we would have a problem. We would be naked one of these options.

Let’s go back to our trade tab, and let’s select the month that we want to sell. In this case, it’s June. We’ll go to the June expiration, and in the Think or Swim platform, it’s very easy to simply right click, and go to “Buy calendar.” It automatically brings up for us the next two months. The front month of the option expiration cycle. In this case, it’s June, which is the one we want to sell. It also brought up the June quarterly options, which is the ones that we do not want to buy. We want to go to July. I’ll tell you why, in just a few minutes.

The price for this calendar spread is $1.29. Let’s go over to the “analyze” tab. You can see that the graph is identical to the one we had before, in which we were purchasing the back month option in July, and selling the front month option in June.

The only difference is, we can enter this order as a spread order, so that it will be filled at the exact same time. The maximum profit of this position, as a calendar spread, is the strike price that we are buying it at, which is $138. As the price moves away from $138, we will make less and less profit.

However, it also has limited risk. In this case, the most we can lose is $129. It’s also the margin required on this position from our broker. They know that the most we can possibly lose in this position is $128. That’s all that they’re going to ask us to set aside, to put this position on.

I mentioned that the maximum loss on this position is $129 – as you can see from this graph, because it’s the margin requirement. Also, you can see that it doesn’t matter how high the price goes. It’s a $129 loss, maximum. It doesn’t matter how low the price goes. It’s a $129 maximum loss.

The maximum profit, is if it continues to be right at the center. Then we’ll collect the maximum amount of profit from this position. The maximum profit from this position is achieved at $138, because that is the option that we sold. It also has the most extrinsic value, $2.61, as position.

I showed you the time graph. What happens is, the front month of the option, and the reason that we make money on this position is, the front month option will decline in value, faster than the month that we’re buying. They will both decline in value, if the price does not move, the closer we get to the June expiration. The difference is, that this option in July – the one that we’re buying to protect our June position – will decline at a slower rate.

The difference between the decline of the June option and the decline of the July option, is our profit. That’s how you make money on a calendar.

We can also discover something very interesting. In the Think or Swim platform, you have this little box, right in the center, above the calls and the puts. If you click down into his blue link here, you can actually call up all of the calendar spreads for this particular month. Let’s take a look at these.

Let’s go back to our June options. There we are, right here. June and July. That’s the one that we’re doing. We have 37 days before June. We have 55 days to July. The current price of the SPY is at 137, so let’s go exactly to the 137 strike price. You can see that the farther out of the money on either side, the least expensive the calendar spreads become.

For example, if we were to purchase the 145 calendar spreads, June-July – that means we’re selling the June 145 calls, and we’re buying the July 145 calls. The price that we would pay is 65 cents. It automatically brings up those two options for us.

I don’t know why they don’t have a lot more strikes on this one. They’re not going to have all the ones that we want, but I’ll use this as an example. The principles are exactly the same

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