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Daily Stock Market Equity and Options Trading Commentary

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Thursday, July 23, 2009

Using Calendar Spread Options on Index ETF's to Profit

In this post I will be writing about an option strategy known as the Calendar Call Spread Option Strategy. To understand this post you'll need somewhat of a background in stock options. To learn more about options and, how options can help protect your portfolio, and allow you to speculate with less money up front click here.

A Calendar Spread option strategy is very similar to the Bull Call Spread option strategy, except that it uses different option expiration dates instead of the same. I will be using three very popular ETF's for my analysis. The ETF's are the: Diamonds Trust, Series 1 (DIA), PowerShares QQQ Trust, Series 1 (QQQQ), and SPDR S&P 500 (SPY).

Calendar Spread Option Strategy #1: Purchase the in the money DIA 50 strike January leap 2011 call option, and sell the in the money 90 strike August 2009 call option against it. The cost of this strategy is $3795 per option contract, and if the stock is assigned at August expiration the profit from this position is $205 per contract or 5.4% (30 calendar days). The position will be profitable (not taking into account commissions) as long as the DIA is at or above $87.95 a share by August 22, 2009 (August options expiration). The current options market is factoring in a 68.0% probability this position will be profitable at August options expiration (above the 88 strike for DIA).

Calendar Spread Option Strategy #2: Purchase the in the money QQQQ 20 strike January leap 2011 call option, and sell the in the money 39 strike September 2009 call option against it. The cost of this strategy is $1760 per option contract, and if the stock is assigned at the September expiration the profit from this position is $140 per contract or 7.95% (58 calendar days). The position will be profitable as long as the QQQQ is at or above $37.65 a share by September 19, 2009. The current options market is factoring in a 64.6% probability this position will be profitable at September options expiration (above the 38 strike for QQQQ).

Calendar Spread Option Strategy #3: Purchase the in the money SPY 50 strike December 31 2010 call option, and sell the in the money 97 strike August 2009 call option against it. The cost of this strategy is $4485 per option contract, and if the stock is assigned at the August expiration the profit from this position is $215 per contract or 4.79% (30 calendar days). The position will be profitable as long as the SPY is at or above $94.85 a share by August 22, 2009. The current options market is factoring in a 65.5% probability this position will be profitable at August options expiration (above the 95 strike for SPY).

When I open option calendar spread positions, I like to purchase contracts which have the longest time until expiration, and like to write the contracts with the closest time until expiration against it (given roughly a 5% return or greater if assigned). If the stock is not assigned at expiration, I simply write it out for a similar strike price for the following month.

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

I've been using this strategy to sell near the money calls on my leap stock options for the short term, and find it to be a great source of generating income for my portfolio. Using these ETF's versus stocks, is a much safer strategy, but won't return as much either. If I want to be long a stock I simply purchase in the money leap options, and write call options for the near term expiration against them. It is a great way to be in the stock, receive income (premiums) month after month (that's if it's not assigned), while returning a profit on the position if the stock happens to be assigned. The downside however is you limit your upside gain for the stock.

In the past 5 years, the volume of option contracts traded has exploded according to the Chicago Board Options Exchange [CBOE]. The reason being is that more and more investor's are finding options to be a good source of income, a great way to hedge their portfolios, and a way to speculate with less cash up front. To see a chart showing options volume over the last 5 years, and to learn more about options in general click here.

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1 comments:

double-a said...

When the option that you sell is executed, what is the result? Must you also have the funds in your account to be able to purchase the shares and if not receive a margin call, or is it like a covered call where it is automatically executed? I have been very successful with covered calls on selected pacific rim ETFs but this may be a better strategy.

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