When I trade any short term time spread in SPX or SPY I almost always use the 3-day rule. When I say short term I mean that the expiration of both the spread’s short and long options is generally within the following 30 days. The 3-days refers to the amount of days between the expiration of the short and long options. And it’s not just any 3 days, it’s the 3 days between Friday and the following Monday. What makes the Friday/Monday expiry so special? I can sum that up with just 2 letters; I and V. If you’re trading options and don’t know that IV stands for implied volatility you should probably take a step back here and do some research on the topic! You can’t trade options successfully without understanding the importance of implied volatility in option pricing! For those of you who sort of understand IV here’s a quick synopsis: the IV percentage tells me how expensive one option is relative to any other option.
Look at the SPX option chain below. The Jun3 SPX 4125 Put has a mark price of $28.15 and the Jun6 SPX 4125 Put has a mark price of $34.45. So which is more expensive? 🤔 Trick question, right? Obviously the Jun6 Put is more expensive on an absolute basis but I need to know how they compare on a relative basis! In options trading, to get an edge when initiating a new time spread trade I want to be able to sell relatively expensive options and buy relatively inexpensive options. So how do I compare their relative values? By this point in the post you should know the answer is those 2 letters, I and V! The IV of the Jun3 Put is 24.11% and the IV of Jun6 Put is 21.31%. Clearly the Jun3 Put is relatively more expensive and, since I’d be selling Jun3 and and buying Jun6, I’m getting a relatively inexpensive time spread. It’s like the CBOE is having a sale on time spreads! Who doesn’t like buying things on sale? 🤩
I’m not going to go into a bunch of examples of the 3-day or Fri/Mon time spreads in this post because you can see numerous examples of where I’ve used those throughout the blog. Just know that wherever you see me discussing a Calendar, Diagonal or RS+ spread that expires within the following 30 days it is a good bet that it is a 3-day or Fri/Mon spread!
A Note from Travis: Like the RS+, the Fri/Mon time spread is another creation of Paul’s that you probably won’t find used, let alone taught, elsewhere. There are many ways to trade time spreads, but most other strategies share a common approach of buying a long leg that is very far out in time and selling a short leg that it much closer in time.
Two things emerge from that approach. (1) Unless the option you sell is much nearer to the money than the long you bought, the spread will be very expensive because you’ll collect relatively little credit relative to the amount you spent for the long. As a result, traders who trade this sort of structure are always incentivized to place their short strike as close to the money. Doing this reduces the cost of the spread but significantly changes the risk profile. (2) The volatility of the two legs of your trade can behave very differently. Sometimes, this is exactly what you want. But you have to plan the trade very carefully. And your trade can end up underwater if vol spikes in short expiry and crashes in your long expiry.
By placing the legs of our time spreads very close together in time (Fri/Mon), we can mitigate both of those risks of a more traditional approach. (1) There is more extrinsic value in our short strike relative to our long strike, which keeps the overall price of our spread reasonable. Since the max risk in a time spread is the debit paid, keep price low helps to control risk. (2) Placing the legs of the spread in expiries that are only a few days apart reduces the risk that displacements in the term structure will cause vol in the expiry of our short strike to rise without also elevating the vol in the expiry of our long strike. This characteristic (combined with the short-dated nature of the spread) helps to make sure that an unforeseen vol event doesn’t blow up the spread. Controlling these variables helps us to focus on the things we want to leverage: direction, gamma convexity, positive theta, and net positive vega.
This doesn’t mean that our time spread approach is “best” or that the others are “bad.” Only that ours is the better tool for the market thesis that we are trying to express in our trade.
Paul/Travis, I use the 3 day (Fri/Mon) time spreads often as well precisely because of the vol difference. I typically like to go to the 15/18 DTE or following week vice the current weeks Fri/Mon exp mainly because in my past the decay between the long and short seemed very linear and I would get stuck in a bad position that looks decent with the risk diagram but in reality is failing pretty bad. Maybe just poor trading and management on my part… have you all experienced this when you are entering within the same week as the Friday exp? I would note I enter the spread at one time I don’t leg in. Thanks for all the info you guys post ALWAYS insightful!
You’re spot on with your analysis of managing a 3 day time spread Richie. Most traders will benefit from initiating them with an approximate 14-21 DTE on the short option and then exiting them before they enter the expiry week, or, at the very least, the Monday or Tuesday of the expiry week. I will typically ‘nest’ multiple spreads so that I have them in 2 to 4 expirys simultaneously but that can get complicated for traders who are new to the strategy. It’s often possible to make a decent profit just by carrying a spread from 3 week’s down to 2 week’s or from 2 week’s down to 1 week until expiry even if price doesn’t move much. That avoids most of the issues of holding into expiry. I appreciate you adding your perspective here and I know some traders will benefit from it. I look forward to more comments from you about your experiences!
Paul, Thanks for the reply! I definitely like the flexibility of time spreads. Lots of options for adjusting and sometimes I like to think of the legs as separate trades all together depending on the market moving, time to expiry in the term etc. I have a full time job so having some flexibility in my trades makes management and handling big swings a lot easier.
On a side note yesterday I picked my kids up from their last day of school so I was home earlier than normal. At 1:30 I took a 0/3DTE (17/21June) calendar using the 3690’s. There was significant amount of open interest and volume at 3700 so I anticipated a pin or at least some chop around there going into the weekend. The 3690 calendar gave me a 50pt spread to stay within and the 5day 4h ATR is ~43 pts so I felt this was a good place to be. I was in at 22.50 and out 2 hours later at 26 for a quick 15% RoR. Time spreads are great even without having to adjust!
Nicely done Richie! Most traders think of a ‘scalp’ as buying the future or a long Put or Call and then selling it a short time later hopefully for a profit. By using a spread to scalp you added positive Theta to the equation so even if price didn’t move you could profit. Thanks for sharing!
any thoughts about doing RS+ using XSP for smaller accounts?
Absolutely! All of the benefits of SPX are available with XSP and the size is more appropriate for smaller accounts. It’s better than using SPY which has some complicating factors such as dividend payments.