Horizontal spread is an option TRADING strategy which is created by simultaneously purchasing and writing two options on the same asset (stock) and strike price but different expiration you date. Horizontal strategy is most known ace Calendar spread because the options there are different expiration dates. Calendar spread, one of many different option spreads, is to neutral strategy.
You only make profit if the underlying price does not move to lot or only moves in a tight range. If the stock rises or drops to lot, you will not get profit because of the volatility. This is to not to not risk option strategy, but it does have low risk. There is not such thing as no risk option strategy. Calendar spread options strategy makes profit from the difference of option premium decay or the difference of implied volatility. Options which is near month expires will lose its value very fast. On to other hand, option which is farther month from expiring will lose its value slowly. Traders will implement to calendar spread by buying option which is farther out and selling a near month.
After some time they will review the position by buying the option they previously sell and selling the option they previously buy. This is also called spread TRADING. Investors can buy call options or buy put options with this strategy. But I prefer using put options because it is cheaper. I will give you an example. Share of a stock XYZ are trading at $50 . To create a calendar spread, you want to buy September $50 call and sell August $50 call. The September call will COST you $6 and August call will give you $4. The $2 spread is the total cost of the strategy. For this strategy to work, you will want August call to lose its VALUE to faster than September call.
In July the options might look like this. August call will worth $1 and September call will worth $4. Your spread will will increase to $3. You profit will sees the spread difference which is $1. In order to work the underlying stock price must remain stable. Any drop or rise will affect the Time VALUE and option price. Calendar spread sees used to make monthly income and that’ s why it is called income strategy. You don’ t need the stock to move to be successful.
For best candidate this strategy looks for channeling or sideways stocks. Those stocks tend to move in a small range. Here are some tips when choosing the stock: Don’ t choose volatile industry like technology or commodity companies. Don’ t have earning release in the coming months. For the news or the their website for possible take to over or mergers.
Using greeks, i can ascertain the probability of an option being exercised. How can I use the probability and volitilty to determine the best risk/reward option to trade? I have been trying delta neutral strategies – do you think that is a valid approach?
Thanks Zman. I was hoping you would answer. It’s clear you have expertise. Do you have a suggestion where i can learn more depth on options as you have? I’ve read many books. . . . are you willing to mentor?
going back to the question. If i adjust Implied vol to determine the current option prices – doesn’t the associated delta reflect the probability? Do you you always adjust your trade to delta neutral?
Selling Options Before Expiration
I admit it. I love options strategies that involve being a net seller of premium. This approach allows me to spend less time managing the trade, more room to be wrong on the direction of the underlying, and best of all, I don’t need a large account to trade. In this article, I want to talk about a few of my favorite premium selling strategies and give some brief pointers on how to trade them with a minimum amount of time investment. Selling Options Before Expiration
Overview of option spreads
Before jumping into a discussion of the strategies, let me give a brief overview of option spreads. The basic idea of a spread is to buy one option and sell another against it. This usually has the advantage of creating a defined risk position but gives up the unlimited profit potential of simply buying an option outright. Variations on spreads include vertical spreads where I buy one option strike in a given month for a specific underlying and sell another option in the same month and same underlying. Calendar spreads involve buying an option strike in one month for a given underlying and selling an option of the same strike price and same underlying but in a different month.
Premium selling strategies
My favorite strategy is the short vertical spread, where I sell an option close to the current trading price of the underlying and buy a strike price farther away from the current price than the strike I sold. This trade is put on for a credit and the risk is limited to the dollar difference between my long and short strike prices minus the credit I received. The maximum profit in this trade is the credit I receive from selling the spread. I will get to keep this credit on expiration if the short strike expires out of the money by $. 01 or more.
Why is this my favorite strategy? Let me use an example to illustrate. Let’s say that SPY, currently trading at $108, has been in a bullish trend of late and my near term (20-40 day) forecast is for SPY to go up more or move sideways. A vertical spread trade I might put on is to sell a put option on SPY at $104 for a month with 20-40 days left until expiration and buy a put option at $102. This is a $2 wide spread and can be put on for $. 50, which means my risk in the trade is $1. 50. For one contract, it will cost me $200 in margin and my max risk is $150.
Once the trade is on, what are the possibilities? SPY can move up strongly and within a week I could close the trade for $. 10 debit locking in $. 40 gain and an ROI of 26%. However, SPY could also go sideways for the next month or even pull back a few dollars. In all of those cases my trade still makes money. Why is that? Because I have sold an out of the money option that is 100% time premium with no intrinsic value. In a case like that, time is my friend. While it’s true I also own a long put option that is also wasting away, it’s value was initially less so if both expire worthless, I end up with a net credit. Selling Options Before Expiration
Creating a trading plan
It’s not enough to simply know about the strategy. To be successful in the long term, I need to have some consistent rules I follow that dictate when to get into a trade, when to get out and how much risk to assume on each trade. These rules together are a key part of an option trading plan. I have one for this strategy, which I’ll briefly outline.
I trade both bullish and bearish short verticals. For this discussion, I’ll talk just about the bullish trade and leave the bearish as an exercise for the reader.
Outlook: Trade this strategy on an underlying (usually an ETF) with an established bullish trend (higher highs & higher lows)
Entry: Look to enter a trade on options with 20-40 days remaining until expiration and I try to sell a few strikes out of the money on the short strike. I also prefer $2 wide spreads as the margin requirement and risk are easily managed
Exit: I have at least one ideal profit target and one ‘worst case’ scenario defined as exits. An easy one for me is what I call the 20%/100% rule. I will exit when there is only 20% of the initial credit left in the trade. I will also exit if the cost to close has grown by 100%. For example, if I put on the trade for $. 50, then my ideal exit would be to close for $. 10 (20% rule), while my ‘worst case’ exit would be $1. 00 (100% rule).
This is obviously a very simple trading plan that needs some more definition but offers a very low maintenance approach to option trading. With many options trading platforms, I can enter my exit rules as a ‘one-cancels-other’ order where both orders are entered and when one triggers to fill, the other is cancelled. That’s it – no muss, no fuss.
Another strategy I like when I’m more neutral is what is known as an iron condor. That’s when I sell both a short call vertical and a short put vertical on the same underlying for the same month. Usually with a $2 wide spread, I’ll have at least $4 between the short put and the short call. So on the SPY position I mentioned, that might be a $114/112 call spread and a $104/102 put spread.
The advantage of this strategy is that it can receive twice the premium with the same amount of risk. Think about it. On expiration, is it possible for SPY to both be above $110 AND below $104? No. So, most brokerages will only hold margin on one side for this kind of trade.
Another strategy I like is a calendar spread. I might buy a $104 put several months out on the SPY and then sell a $104 put out 20-40 days until expiration. This is actually a debit spread but is still considered a premium selling strategy. It’s a little longer term strategy but can pay quite well.
These are my bread and butter trades. I can trade them no matter what the market is doing and they continue to do well for me. Selling Options Before Expiration