Recently in MTM’s Group Coaching class, we talked about a long double calendar on SPY. The interesting part about the conversation was that Fed Chair Powell was speaking the next day at the Jackson Hole Symposium. A volatile day might ensue the next session.
Implied Volatility Skews
At the time we were looking at the trade, the S&P 500 ETF (SPY) was trading just over the $416 level. I suggested considering this trade toward the close and potentially basing short strikes off where it was closing. The ETF was trading around the $420 level toward the close. We looked at selling Friday’s expiration (the next day) and buying Monday’s expiration. There was a favorable implied volatility (IV) skew as well. The short expiration IV was around 30.5% and the long expiration was around 19.5%. The position would be selling higher priced options than what was bought because of the expected volatility event the next day.
Modeling It Out
An option trader could have chosen strikes that were about $5 from where the underlying was trading. For this example, a long 425 call calendar and a long 415 put calendar could have been chosen. It could have looked something like this…
The cost and max risk in this example was 1.20. Max profit would be earned exactly at $415 or $425 at Friday’s close. With any calendar, including this double calendar, the P&L diagram is an estimate. In this case, it looked like this…
The P&L diagram estimated the break-evens would be around $410 to the downside and $430 to the upside. The max profit was estimated to be around $190 at Friday’s close. Essentially, on paper, an option trader would have about a $20 range to profit.
Finally
There are lots of moving part with calendars, including changes in IV, theta and of course the underlying. But on paper, and many times in real situations, they give option traders a fairly wide area to potentially profit.
I hope that helps!
Trade Smart.
Dan Passarelli
Founder and President
Market Taker Mentoring
