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Calendar Spread Trade on Noble Corp (NE)

A CALENDAR SPREAD that involves selling the January ’12 37 call and buying the January  ’13 33 call should cost $32.59 less per share than the covered call and potentially yield a 100% return if the stock stays above $37 through expiration

TRADE:  Noble (NYSE: NE) ended the last trading session at $37.79.  So far the stock has hit a 52-week low of $27.33 and 52-week high of $46.72.  NE has had an S&P 4 STARS (out of 5) ranking since 6/8/2010.  On 7/21/2011 S&P equity analysts set a 12-Month price target of $47.00 for the stock.   Noble stock has been showing support around $36.76 and resistance in the $38.52 range.  NE is part of the S&P 4 STARS stock list.  One way to play this stock would be with a calendar spread that substitutes a longer term call option in place of the covered call stock purchase.  To use this strategy consider going long the NE Jan ’13 33 Call and selling the Jan ’12 37 call for a $2.00 debit.  The strategy has a 75 day life and would provide 7.38% downside protection and a 100.00% assigned return rate for a 486.67% annualized return rate (for comparison purposes only).

RISK: The Calendar spread strategy will normally carry more risk than a covered call strategy, but the rate of return is generally higher, since there is a lower capital outlay.  At a 3 Key risk ranking this strategy is considered to have moderate relative risk.  If the stock price at expiration is below $37 this strategy will not generate the potential returns shown. Another risk for this strategy is related to the bought Call Option price.   If the stock drops in price between now and
expiration date, there is a possibility that the Jan ’13 33.00 call could drop quickly.

Calendar Spread on Kinder Morgan (KMP)

STRATEGY DISCUSSION: Kinder Morgan (NYSE: KMP) ended the last trading session at $76.34. So far the stock has hit a 52-week low of $63.42 and 52-week high of $78.00. KMP has had an S&P 5 STARS (out of 5) ranking since 8/23/2007.  On 4/21/2011 S&P equity analysts set a 12-Month price target of $88.00 for the stock. Kinder Morgan stock has been showing support around $75.18 and resistance in the $76.98 range. KMP is part of the S&P 5 STARS stock list.  A way to play this stock would be with a calendar spread that substitutes a longer term call option in place of the covered call stock purchase. To use this strategy consider going long the KMP Jan ’13 67.50 Call and selling the Jan ’12 75 call for a $6.00 debit. The strategy has an 82 day life and would provide 3.72% downside protection and a 25.00% assigned return rate for an 111.28% annualized return rate (for comparison purposes only). This strategy has a 3 Key (out of 5) Moderate Relative Risk ranking.  Kinder Morgan has a current annual dividend yield of 5.91%.

TRADE: A CALENDAR SPREAD that involves selling the January ’12 75 call and buying the January ’13 67.50 call should cost $66.89 less per share than the covered call and potentially yield a 25% return if the stock stays above $75 through expiration.  S&P set a $88.00 12-Month price target for KMP which is currently trading at $11.66 below that target.  With the calendar spread trade, the trade cost could be reduced and returns potentially improved if the stock stays above $73.55 but lower than $95.43.

RISK: The Calendar spread strategy will normally carry more risk than a covered call strategy, but the rate of return is generally higher, since there is a lower capital outlay. At a 3 Key risk ranking this strategy is considered to have moderate relative risk. If the stock price at expiration is below $75 this strategy will not generate the potential returns shown. Another risk for this strategy is related to the bought Call Option price.  If the stock drops in price between now and expiration date, there is a possibility that the Jan ’13 67.50 call could drop quickly.

Get more calendar spreads.

Kinder Morgan Energy Partners Stock Chart

Kinder Morgan Energy Partners Stock Chart by YCharts

List of Calendar Spread Trades for August 2011

Below is a list of potential calendar call spreads for further evaluation.  There is an option to purchase shown in the buy side column.  These options are the January 2012 call options.  The sell side column shows the option to sell in the August 2011 listing for each stock.  All other metrics are based on the previous closing price and current option pricing.  These will change depending on the market prices of each stock.  You should watch for earnings releases and actively manage these trades.

Click to enlarge

Exxon Mobil Corporation (XOM) is a manufacturer and marketer of commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics and a range of specialty products. It also has interests in electric power generation facilities. It has many divisions and hundreds of affiliates with names that include ExxonMobil, Exxon, Esso or Mobil. Divisions and affiliated companies of ExxonMobil operate or market products in the United States and other countries of the world. Their principal business is energy, involving exploration for, and production of, crude oil and natural gas, manufacture of petroleum products and transportation and sale of crude oil, natural gas and petroleum products. On June 25, 2010, it acquired XTO Energy Inc. by merging a wholly owned subsidiary of ExxonMobil with and into XTO. In October 2010, Global Partners LP acquired retail gasoline stations from Exxon Mobil. In June 2011, the Company acquired Phillips Resources.
Philip Morris International Inc. (PM) is a holding company. PMI, through its subsidiaries and affiliates and their licensees, is engaged in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States of America. As of December 31, 2010, its products were sold in approximately 180 countries. Its portfolio comprises both international and local brands, which include Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris and Red & White. PMI also owns a number of local brands, such as Sampoerna A, Dji Sam Soe and Sampoerna Hijau in Indonesia, Fortune, Champion and Hope in the Philippines, Diana in Italy, Optima and Apollo-Soyuz in Russia, Morven Gold in Pakistan, Boston in Colombia, Belmont, Canadian Classics and Number 7 in Canada, Best and Classic in Serbia, f6 in Germany, Delicados in Mexico, Assos in Greece and Petra in the Czech Republic and Slovakia.
General Motors Company (GM) is a global automotive company. It develops, produces and markets cars, trucks and parts worldwide. GM also provides automotive financing services through General Motors Financial Company, Inc. (GM Financial), formerly AmeriCredit Corp. (AmeriCredit). These financing operations consist principally of financing automobile purchases and leases for retail customers. The Company operates in five segments: GM North America (GMNA), GM Europe (GME), GM International Operations (GMIO), GM South America (GMSA) and GM Financial. GM Financial is an automotive finance company. GM Financial purchases automobile finance contracts for new and used vehicles purchased by consumers primarily from franchised and select independent dealerships. On October 1, 2010, GM completed the acquisition of GM Financial. In February 2010, GM completed the sale of Saab Automobile AB (Saab). In May 2010, the Company completed the sale of Saab Automobile GB (Saab GB).
Oracle Corporation (ORCL) is an enterprise software company. The Company develops, manufactures, markets, distributes and services database and middleware software, applications software and hardware systems, consisting primarily of computer server and storage products. It operates in three segments: software, hardware systems and services. Its software business is consisted of two operating segments: new software licenses and software license updates and product support. Its hardware systems business consists of two operating segments: hardware systems products and hardware systems support. Its services business is consisted of three operating segments: consulting, On Demand and education. In January 2010, the Company acquired Sun Microsystems, Inc. and Silver Creek Systems, Inc. In January 2011, the Company completed the acquisition of Art Technology Group (ATG), Inc.
General Mills, Inc. (GIS) is a global manufacturer and marketer of consumer foods sold through retail stores. The Company is also a supplier of food products to the foodservice and commercial baking industries. General Mills manufactures its products in 15 countries and markets them in more than 100 countries. The Company’s joint ventures manufacture and market products in more than 130 countries and republics worldwide. The Company’s businesses are organized into three operating segments: U.S. Retail, International, and Bakeries and Foodservice. The Company sells ready-to-eat cereals, through its Cereal Partners Worldwide (CPW) joint venture. The Company’s primary customers include grocery stores, mass merchandisers, membership stores, natural food chains, drug, dollar and discount chains, commercial and noncommercial foodservice distributors and operators, restaurants and convenience stores. In July 2011, it acquired 51% controlling interest in Yoplait S.A.S.

Trading a Calendar Spread with LEAPS

Previously, we posted information on doing a covered call using a LEAPS option. Call calendar spreads are similar to a covered call. One part of the call calendar spread is buying a LEAPS call instead of owning the stock. Then, we can sell call options (like a covered call) with less time to expiration (the calendar part). For example, we can buy a call LEAPS with two years of time and sell a call option in the next month. It the strike price of the LEAPS is the same as the call sold, then you have created a call calendar spread. It the strike prices are different, then we have created a diagonalized calendar spread.

My preference is to buy a LEAPS that is in-the-money. This gives you a higher delta so you captured more of the stock price move. A good target is to buy a LEAPS call with a delta of 0.70 or higher. If the stock makes a strong up move, then you gain more profits in the LEAPS call. Also, ITM LEAPS give us more choices in what strike prices to sell the call. In comparison to a covered call with stock, we DO NOT want to e exercised in the LEAPS position. The reason is simply that we do not want to lose the time value of the LEAP call. You can buy an ATM or OTM LEAPS call, but your delta will be lower and it is more difficult to sell a call until the stock price moves up.

When I sell a call, I like to sell the shortest amount of time available because it will decay faster (more profit per day due to time decay) than a call with several months of time. I like to use the existing month and the next month for call sells. I like to sell an OTM call when holding a LEAPS because the call sold is all time value.

The bottomline: Your returns will be leveraged. For example, you may get a 3% return on a covered call but that same return will be 12% if your underlying is a LEAPS instead of stock. Since we are using LEAPS, if the short call strike price is above the stock then it will expire worthless. You can then sell a call against the LEAPS for the next month. If the stock price is greater than the short call, you can back back the short call or roll it up to a higher strike price.

FYI:  See the top 50 calendar spreads on the options caculator page.  This list is based on simple calendar spreads with the same strike price for lomg and short options.

Calendar Spread Trades for July 2011

Below is a list of potential calendar call spreads for further evaluation.  There is an option to purchase shown in the buy side column.  These options are the January 2012 call options.  The sell side column shows the option to sell in the July 2011 listing for each stock.  All other metrics are based on the previous closing price and current option pricing.  These will change depending on the market prices of each stock.

CLICK to Enlarge.

ABX – Barrick Gold Corporation is engaged in the production and sale of gold, as well as related activities, such as exploration and mine development. It also produces copper, and hold interests in oil and gas properties located in Canada through its oil and gas subsidiary, Barrick Energy. Its producing mines are concentrated in three regional business units: North America, South America and Australia Pacific. In addition, it has a Capital Projects segment, distinct from its regional business units, to focus on managing projects. As of December 31, 2010, it held a 73.9% interest in African Barrick Gold plc, which included its previously held African gold mines and exploration properties. Its main properties include Goldstrike, Cortez, Lagunas Norte, Veladero, Zaldivar and Porgera mines and its Pueblo Viejo and Pascua-Lama projects. On September 17, 2010, it acquired the assets of Dolomite Resources. On June 25, 2010, it the Puskwa property from Galleon Energy Inc.

FFIV – F5 Networks, Inc. (F5 Networks) is a provider of technology that optimizes the delivery of network-based applications and the security, performance and availability of servers, data storage devices and other network resources. Its technology is hardware and software for application delivery networking, including application security, secure remote access, policy management, wide area network (WAN) optimization and file virtualization. Its principal products are systems that integrate its software with purpose-built hardware that incorporates commodity components. In addition, it introduced a virtual (software only) version of BIG-IP called BIG-IP LTM (VE) that is designed to run on servers and work in conjunction with its systems to provide management of virtual servers and applications. Its BIG-IP product family, which represents the bulk of its sales, supports a growing number of features and functions available as software modules, standalone appliances, or both.

CHK – Chesapeake Energy Corporation (Chesapeake) is a producer of natural gas in the United States. It owns interests in approximately 44,100 producing natural gas and oil wells that are producing approximately 2.4 billion cubic feet equivalent (bcfe), per day, 93% of which is natural gas. The Company is focused on discovering, acquiring and developing conventional and unconventional natural gas reserves onshore in the United States. It also has operations in the Granite Wash Plays of western Oklahoma and the Texas Panhandle regions, and in the Mid-Continent, Appalachian Basin, Permian Basin, Delaware Basin, South Texas, Texas Gulf Coast and Ark-La-Tex regions of the United States.

GM – General Motors Company (GM) is a global automotive company. It develops, produces and markets cars, trucks and parts worldwide. GM also provides automotive financing services through General Motors Financial Company, Inc. (GM Financial), formerly AmeriCredit Corp. (AmeriCredit). These financing operations consist principally of financing automobile purchases and leases for retail customers. The Company operates in five segments: GM North America (GMNA), GM Europe (GME), GM International Operations (GMIO), GM South America (GMSA) and GM Financial. GM Financial is an automotive finance company. GM Financial purchases automobile finance contracts for new and used vehicles purchased by consumers primarily from franchised and select independent dealerships. On October 1, 2010, GM completed the acquisition of GM Financial. In February 2010, GM completed the sale of Saab Automobile AB (Saab). In May 2010, the Company completed the sale of Saab Automobile GB (Saab GB).

MHS – Medco Health Solutions, Inc. (Medco) is a healthcare company. It provides clinically-driven pharmacy services designed for private and public employers, health plans, labor unions and government agencies of all sizes, and for individuals served by Medicare Part D Prescription Drug Plans. The Company operates in two segments: Pharmacy Benefit Management (PBM) and Specialty Pharmacy. Medco’s advanced pharmacy and clinical research are part of Medco making medicine smarter for more than 65 million members. It offers clinically-based programs that identify drug waste. Pharmacy management includes mail-order service, retail pharmacy networks, specialty pharmacy management, call center pharmacies and reimbursement services. Its Internet-based services offer sites for clients and retail pharmacists that provide interactive tools. On January 29, 2010, the Company completed the acquisition of DNA Direct Inc. On September 16, 2010, Medco acquired United BioSource Corporation (UBC).

How To Trade The Calendar Spread for Income

A calendar spread, which is often referred to as a time spread, is the buying and selling of a call option or the buying and selling of a put option of the same strike price but different expiration months.  In essence, you are selling a short-dated option and buying a longer-dated option.  This means that the result is a net debit to the account.  In fact, the sale of the short-dated option reduces the price of the long-dated option, making the trade less expensive than buying the long-dated option outright.  Because the two options expire in different months, this trade can take on many different forms as expiration months pass.

There are two types of long calendar spreads: call and put.  There are inherent advantages to trading a put calendar over a call calendar, but both are readily acceptable trades.  Whether you use calls or puts depends on your sentiment of the underlying investment vehicle.  If you are bullish, you would buy a calendar call spread.  If you are bearish, you would buy a calendar put spread.

A long calendar spread is a good strategy to use when you expect prices to expire at the value of the strike price you are trading at the expiry of the front-month option.  This strategy is ideal for a trader whose short-term sentiment is neutral.  Ideally, the short-dated option will expire out of the money.  Once this happens, the trader is left with a long option position.

If the trader still has a neutral forecast, he or she can choose to sell another option against the long position, legging into another spread.  On the other hand, if the trader now feels the stock will start to move in the direction of the longer-term forecast, he or she can leave the long position in play and reap the benefits of having unlimited profit potential.

How to Find Calendar Spread Candidates

 • Check the current value of implied volatility (IV) and the history of IV over the past three to six months (free at ivolatlity.com).  Be sure the current IV is in the bottom quartile of recent IV history.

• Don’t trade a negative IV skew (if ≤ 2 points, maybe… but doubtful).

• Investigate very carefully if the positive IV skew is ≥ 4 points (suggests a big move is expected).

• Calculate the standard deviation (σ) for the candidate stock; use current IV and number of days to expiration of the front month option; look at the price range (lowest to highest) of the past week and the past month; avoid this stock if the recent price ranges are > 1 σ.

• Be sure no earnings announcements or other significant announcements are pending during the course of the proposed trade.

• Be sure you are selling > $0.40 of option premium (otherwise, commissions eat up too much of your profit).

• Calculate the breakevens (BE) using your trading software; you want a broad range between the BEs.

• Low IV stocks (12–‐20%) are conservative but require a large number of contracts; consider the effect of commissions.  Stocks with higher IVs (≥ 20%) present more price movement risk but have large premiums

Managing the Trade – Making Trade Adjustments

 • When you have traded calendar spreads for at least 6 months, you may consider adjustments. Until then, simply close the trade when the stock price hits a BE or the trade hits the stop loss you established. 

• Use the BEs or a price just beyond the BEs as your trigger.

• Close a portion of your contracts and place another calendar at or near the new price; determine the number of contracts to close and roll up or down by the number it takes to move your position delta back closer to zero.

• For example, IBM is at $172 and we put on 10 contracts of a $175 call calendar. IBM moves to $176 (our upper BE); we close 4 of our $175 calendars and open 4 $180 call calendars.  If we think IBM may move even higher, we might place the new spreads at $185.

• Don’t adjust a trade if you have < 15 days left to expiration (unless you have multiple months, e.g., you have a Jun Sep $175 call calendar; we close some or all of our Jun $175 calls, and wish to roll up to $180 but we only have 8 days to expiration; then you would sell the July $180 calls).

• Manage the new calendar spread just like the original trade (write down your management criteria).

In summary, it is important to remember that a long calendar spread is a neutral – and in some instances a directional – trading strategy that is used when a trader expects a gradual or sideways movement in the short term and has more direction bias over the life of the longer-dated option.   This trade is constructed by selling a short-dated option and buying a longer-dated option, resulting in a net debit.  This spread can be created with either calls or puts, and therefore can be a bullish or bearish strategy.  The trader wants to see the short-dated option decay at a faster rate than the longer-dated option.  The time decay is your income just like it is in the covered call trade.

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