The Call Calendar & Looking Ahead

WMT (Walmart) looks to be setting up for some serious considerations on this type of trade. With Earnings today flat, and movement is not overly volatile, this trade could pay off. However, I need to set my exit plans and crunch some numbers. I will be waiting for early next week before I make a move...If I make a move.
I am defining 48 as some strong support and with the move today and going into the weekend I will be watching to see if it holds or we go lower.

Education Segment:

The neutral calendar spread strategy or call calender, involves buying long term calls and simultaneously writing an equal number of near-month at-the-money or slightly out-of-the-money calls of the same underlying security with the same strike price.

Neutral Calendar Spread Construction

Sell 1 Near-Term ATM Call Buy 1 Long-Term ATM Call

The options trader applying this strategy is neutral towards the underlying for the short term and is selling the near month calls to profit from their rapid time decay.

Limited Profit Potential

The maximum possible profit for the neutral calendar spread is limited to the premiums collected from the sale of the near month options minus any time decay of the longer term options. This happens if the underlying stock price remains unchanged on expiration of the near month options.

Neutral Calendar Spread Payoff Diagram

Limited Downside Risk

The maximum possible loss for the neutral calendar spread is limited to the initial debit taken to put on the spread. It occurs when the stock price goes down and stays down until expiration of the longer term options.

Example

In June, an options trader believes that XYZ stock trading at $40 is going to trade sideways for the next few months. He enters a neutral calendar spread by buying a OCT 40 call for $400 and writing a JUL 40 call for $200. The net investment required to put on the spread is a debit of $200.

As expected, the stock price of XYZ closes at $40 on expiration date of the near term call and the JUL 40 call expires worthless. The long term call lost some value due to time decay but is still worth $350. Selling this call nets him a $150 profit after taking into account the initial debit of $200.

If the price of XYZ had instead declined to $37 and stayed at $37 until October, both options expire worthless. The trader will also be unable to write additional calls since they are too far out-of-the-money to bring in significant premiums. Hence, he will lose his entire investment of $200, which is also his maximum possible loss.

Follow-up Action on Near-Term Expiration

Like all calendar strategies, it is necessary to decide on which follow-up action to take when the near-term options expire. This decision depends heavily on the revised outlook of the underlying stock at that time.

Should the neutral calendar spread trader thinks that the underlying volatility will remain low, then he may wish to enter another calendar spread by writing another near term call.

If he thinks that the volatility is likely to increase significantly, he may wish to hold on to the long term call to profit from any large upward price movement that may occur.

However, if the options trader is unsure of what to expect of the underlying, it may be best to take profit (or loss) and move on to evaluate other trading possibilities.

Note: While we have covered the use of this strategy with reference to stock options, the neutral calendar spread is equally applicable using ETF options, index options as well as options on futures.

Commissions

For ease of understanding, the calculations depicted in the above examples did not take into account commission charges as they are relatively small amounts (typically around $10 to $20) and varies across option brokerages.

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Maybe Time to Adjust on RIMM Iron Condor

Yesterday was the day for me to start thinking about possible adjustments...Have I made any yet...? NO...Do I need to take action right away...? Maybe. Regardless, I was away from my computer all day yesterday, and really was not looking at want the market did. However, last night I was able to check out the moves and news, and saw that RIMM moved below 70 and had an intraday double bottom. Then today, RIMM dropped below 70 early and hovered there till the close. This kind of move in a lot of cases will promote panic, and a lot of the time cause me to make a miscalculated move. So I now take the time to look at the trade, look at my exit plan that was thought of before placing the trade and crunch the numbers to see what my possibilities are...

Possible Adjustments:
Step 1: Where does the trade stand?
RIMM closed today (5/13) at 69.09
The total credit in the trade is 1.50 this means that my lower breakeven is not been met yet, BUT the trade looks negative. Meaning if I were to close the whole trade now I would lose more then just commissions. Why? because of something called Extrinsic Value or Time Value (The component of the premium paid for an option that reflects the value of time remaining before expiration.)
With the remaining time left till the options expire and that the stock has dropped about 5% since the close on Monday. There has been a bit of premium build up in the option since the position was opened on the 6th.

Step 2: How much will I loss? If anything.
The Bear Call side of the Iron Condor is basically worthless...So no need to take any action there. It is the Bull Put side of the Iron Condor that I am concerned about...I only received a $.034 credit for this side of the trade when it was opened and If I were to close it now, it would cost approximately $1.70 plus commissions. So assuming I closed this side of the trade and that the bear call did indeed expire worthless...I would lose about $0.20 plus commissions on 6 legs. 4 legs when opened the trade, and 2 more legs to close. If I am paying $1.00 per contract and I have a total of 10 contracts per leg that would be an added $60.00 that I need to account for.
Total loss = $0.20 x 1000 shares + $60.00 That is $260.00 Loss

This is not to bad when you consider losing the max risk in the trade, which is 3.50 per share at 1000 shares that is $3,500 on the line. So I very easily could close the trade early and walk away with no big worries.

The Bottom Line:
For the next 2 days I will be looking to exit this trade with as little out of pocket cost possible. That may be Thursday or Friday...I don't want to Roll the Bull Put side of the trade out to June because of earnings that month.
The action I will take if RIMM stays below 70 before expiration will be:
Sell To Close (STC) 65 Long Put for the bid price
Buy To Close (BTC) 70 Short Put for the ask price
What ever the values are or will be at the time. I don't like to set up limit orders in this situation. I want out when I submit the order.

If you have any questions please contact me via email at coachnuge@gmail.com
Private Tutoring is available.

A Look at the 4 Option Instruments

Iron Condor on RIMM

As we get closer to expiration day, I like to look for this type of trade.

The Iron Condor on RIMM

With this type of trade it is really important to define some levels of support as well as resistance. You also need to have a good and reasonable exit plan.

Not seeing any catalyst to push RIMM above Resistance at or near 80 in the next week. Support at least for the short term (the next week) at or near 70. Will 70 hold up? I have identified it as resistance until it was broken on Friday the 1st. One rule that I have found to be useful is that when resistance is broken it tends to act as new support. So that is what I am going on here. At least for the short term…

SET UP on MAY 6th:
STO the May 80 Call and Simultaneously,
BTO the May 85 Call for a Net Credit of $1.16

STO the May 70 Put and Simultaneously,
BTO the May 65 Put for a Net Credit of $0.34

Total Credit = $1.50 x 10 Contracts = $1,500
Total Risk = $3.50 X 10 Contracts = $3,500

This is about a 40% Risk/Reward Ratio.

Max Reward ($1,500 - commissions) is ONLY achieved if the stock price remains between the 2 short options and the options expire worthless.
Where this trade losses is if the stock trends outside of the BreakEven (BE) points. There are 2, upside BE and downside BE.

Upside BE = 81.50
Downside BE = 63.50
What this tells me is that from the time this trade was initiated (May 6th) to the Saturday Following the 3rd Friday (Expiration) of May the stock can move as high as 81.50 and as low as 63.50. That is 18 point gap. RIMM was trading about $77 that day so this give me about a 5% cushion on the upside and about 17% cushion to the downside.

This trade is going to take full advantage of TIME DECAY or THETA
As long as the options remain out of the money (OTM) they will become cheaper and cheaper, so in the case IF i needed to close one side of the trade or the other, it would not cost me as much to close as the credit received when I opened the trade. For more clarity on the GREEKS contact me via email: coachnuge@gmail.com

EXIT PLAN:
Primary Exit defines what I am going to do if...based on my expectations? That would be stock trades between 70 and 80 per share till expiration, I would need to do nothing, options would expire worthless. Max Reward would be achieved Minus commission of course. If your commission is say $1.00 per contract that would be 10 contract per leg and there are 4 legs to this trade. That would = 40 x $1.00
Profit = about $1,460 ($1,500 - $40)
Return on Investment = 41%

Secondary Exit defines what am I going to do if my expectations are wrong? The Secondary Exit is really design to help control my FEAR of losing everything...don't want that to happen so first I am going to pay close attention to my BreakEven Points and if things are to close or setting up to break out up or down I am looking to close the trade early. So I am watching the news surrounding the stock and the industry as a whole. Paying close attention to volume (is it rising or falling, this helps to identify momentum building or slowing down)

That fact of the matter is that I am playing the Iron Condor like I would if I had a Bear Call and a Bull Put on the same stock.
If RIMM breaks down below my support at 70 I will not be looking to take the assignment of the Short Put and buy the stock. I know what I can afford and RIMM at 70 is not something I can afford at this time. If I cannot close the Put side of the trade without taking a big loss I will look to ROLL the whole trade out to the next month using lower strikes. NEED TO KNOW THE MATH...How this will affect the new credit, look back at my technical analysis, can support be validated with the new time frame (next 30 days or so?) If yes, I am doing it making the adjustment and reestablishing my new exit plan.


Any Questions Contact Coach Nuge via Email: CoachNuge@gmail.com

Iron Condor

The iron condor is a limited risk, non-directional option trading strategy that is designed to have a large probability of earning a small limited profit when the underlying security is perceived to have low volatility. The iron condor strategy can also be visualized as a combination of a bull put spread and a bear call spread.

Iron Condor Construction

Sell 1 OTM Put Buy 1 OTM Put (Lower Strike) Sell 1 OTM Call Buy 1 OTM Call (Higher Strike)

Using options expiring on the same expiration month, the option trader creates an iron condor by selling a lower strike out-of-the-money put, buying an even lower strike out-of-the-money put, selling a higher strike out-of-the-money call and buying another even higher strike out-of-the-money call. This results in a net credit to put on the trade.

Limited Profit

Maximum gain for the iron condor strategy is equal to the net credit received when entering the trade. Maximum profit is attained when the underlying stock price at expiration is between the strikes of the call and put sold. At this price, all the options expire worthless.

The formula for calculating maximum profit is given below:

• Max Profit = Net Premium Received - Commissions Paid
• Max Profit Achieved When Price of Underlying is in between Strike Prices of the Short Put and the Short Call

Iron Condor Payoff Diagram

Limited Risk

Maximum loss for the iron condor spread is also limited but significantly higher than the maximum profit. It occurs when the stock price falls at or below the lower strike of the put purchased or rise above or equal to the higher strike of the call purchased. In either situation, maximum loss is equal to the difference in strike between the calls (or puts) minus the net credit received when entering the trade.

The formula for calculating maximum loss is given below:

• Max Loss = Strike Price of Long Call - Strike Price of Short Call - Net Premium Received + Commissions Paid
• Max Loss Occurs When Price of Underlying >= Strike Price of Long Call OR Price of Underlying <= Strike Price of Long Put

Breakeven Point(s)

There are 2 break-even points for the iron condor position. The breakeven points can be calculated using the following formulae.

• Upper Breakeven Point = Strike Price of Short Call + Net Premium Received
• Lower Breakeven Point = Strike Price of Short Put - Net Premium Received

Commissions

Commission charges can make a significant impact to overall profit or loss when implementing option spreads strategies. Their effect is even more pronounced for the iron condor as there are 4 legs involved in this trade compared to simpler strategies like the vertical spreads which have only 2 legs.