This post is for every type of trader but especially those who either don’t have the time or the ability to trade all day long. Even those traders who can trade at any time it’s good to have a primary position that is in the direction of the underlying trend that doesn’t need to be adjusted or ‘tweaked’ at all. Just buy and hold! I realize that those words ‘buy and hold’ just triggered most of you short term traders 😱 but read the post before you give up on the concept! You can still do your day trades and scalps or whatever you do but there’s nobody that couldn’t benefit from the Calendars that you’re about to see. First, let’s establish the trend.
SPX has been on a rally since 12/22/22 as evidenced by the rising 8 SMA bands. The bands began to rollover about 5 days ago and are now declining. As long as price doesn’t close a daily candle above the upper band which is now 4134 and dropping daily then the current trend is down.
Now I need to identify potential targets for the coming decline. I’ll use the typical Fib retracement zone that I always use which is the 50%-61.8% zone plus I’ll add the 78.6% level in case the SPX decline is greater than a standard retracement. To be perfectly clear, I have no idea whether price will reach any of those Fib levels, or if it does, whether price will find support there or just keep on dropping. Regardless, I need a target for my option trade(s) so I’ll be using the 3800-4000 range.
Lets say the budget for my bearish SPX trade is $400-$500. That is the amount I’m willing to lose IF price rockets higher. It’s more likely I’d lose less than half of that because I would stop out of these trades IF SPX closes above the upper band in the next week. After that, if price continues lower then the 8-day SMA upper band will be declining and so will my stop levels. I could buy 3 Mar17/20 SPX 4000 Put Calendars for $435. Why Mar17/20? Why not less time? The longer amount of time makes the spreads less expensive and reduces the Delta risk of the position. I could use less Days to Expiration (DTE) but with a with a really wide (see Triple Calendar further down in the post) and cheap spread I’m attempting to allow for price volatility with lots of movement within a large range. This trade could absolutely be initiated with less DTE and more Delta risk and a higher cost. As with all option trades there is no one best solution. See the risk profile for the Greeks and the potential profit if SPX is near 4000 on Mar17.
Below is a series of different combinations of Put Calendar spreads using 2 and 3 different strike prices and different quantities. Look at the Greeks and the potential profits of each profile at each strike. The combination below would cost $430.
The combination below would cost $425.
The Triple Calendar combination below would cost $400. (I love a bargain!)
The combination below would cost $540. I know, I got a little carried away here but it looks so good! 😍
The combination below would cost $515. Also over budget like the previous combination but if I was expecting a particularly bearish move this would reward me the most. The breakeven range is from just below the current price to around 9% lower.
I like to confirm that what the risk profile is showing as a potential maximum profit on those combinations is accurate. I test that by comparing it to what the actual price of a Put Calendar was worth in the past. First, I have to pick a date from the past which I think will have a VIX price level that is similar to what I expect by Mar17 IF SPX drops by as much as 9%. The 10/7/22 VIX closed around 31. That level was reached multiple times in the past year when SPX was down sharply so that’s a reasonable assumption.
Below is the option chain for SPX on 10/7/22. The at-the-money (ATM) Put was worth about $25 so that’s a reasonable expected value of an ATM Put on Mar17. That means if SPX is near 3800, 3900, or 4000 at the close on Mar17 then, if I’m holding a Triple Calendar with those 3 strikes, it’ll be worth a minimum of $2,500. As a reminder, the cost of the straight Triple Calendar was $400 so that’s a pretty good return for a relatively wide profit range! I would still own 2 other Calendars other than the one that is nearest to the money so that could add additional value to the Triple Calendar.
Now I know many of you have tried Double or Triple Calendars in the past and found them to not be as advertised. Often, the profit ‘tent’ collapses down to where the once great looking risk profile drops ‘underwater’ where there’s no chance of making a profit. If that’s happened to you in the past it’s because the cost of the 2 or 3 Calendars exceeded the expected maximum profit assuming a VIX that is dropping instead of rising. If I bought a Call Triple Calendar and paid around $2.50-$3.00 for each of the three Calendars then my total cost would be around $8.00 and, even if SPX got near one of the strikes at expiry, the maximum value of that ATM Calendar might be less than $8.00 meaning I would then have a loss! That is unlikely to happen IF you pay less than $2.00 each for a Calendar and that’s especially true if the VIX goes up instead of down.
2/25/2022 Update: Below is the current risk profile of the standard Triple Calendar (shown above) using the costs that were available when I wrote this post. SPX closed at 3970 this week compared to 4079 last week which is a decline of 2.7% and the VIX closed this week at 21.67 compared to last week’s close at 20.02 which is an increase of 8.2%.
I’m showing 2 additional risk profiles below to address a question with regards to the alternative of using a Calendar(s) with more than 3 days between the short and long options of the spread. For instance, I might buy a Mar3/17 Put Calendar with 14 days between the front and back end of the spread. IF price closes at or above the Calendar’s strike price on Mar3 then I can sell the Mar10 Put at the same strike and bring in more premium. Below is that example. I could make approximately $4,500 in the next week plus be able to sell the Mar10 Put to bring in additional premium.
The biggest downside to that strategy is the initial cost. I’ve shown how much would be lost if SPX were to rally 1% or 2%. A rally of 2% in the first day would lose almost $1,000 which is approximately 50% of the cost of the spread. A 1%-2% overnight rally in the SPX futures isn’t uncommon so I could easily find myself with that size of loss without being able to exit the trade.
Below is the risk profile of the Mar17/20 SPX Calendar with the same 3800 strike price as the above example. The reason I show a quantity of 13 is to bring the total amount invested to equal that of the previous example. The Mar3/17 Put Calendar cost $2,140 and 13 of the Mar17/20 Put Calendars costs $2,145. A rally of 2% in the first day would lose almost $600 which is approximately 28% of the cost of the spread. The other side of that equation is that I would make very little profit IF price dropped towards the 3800 target area on the first day. So which is better? As with almost all option trades made it depends on your underlying price expectation.
In the first paragraph of this post I said “it’s good to have a primary position that is in the direction of the underlying trend that doesn’t need to be adjusted or ‘tweaked’ at all. Just buy and hold!” With that being my objective then initiating the position as a very wide and cheap Triple Put Calendar will best help me achieve that goal. I don’t want much Delta risk that could force me to stop out of the position early if SPX moves 2%+ higher because it could do that and still be in a downtrend on the daily chart using the 8 SMA as the trend indicator. A single Put Calendar wouldn’t give me enough width to the profile to endure a big drop in SPX while still profiting from a slow drift lower in price. If I expected a quick drop in SPX I would use a shorter dated Calendar having anywhere from 7-14 DTE. An OTM Calendar with shorter duration has a greater Delta risk which is what I would want under that scenario. So, again, it all depends on what your expected scenario is for the underlying price action over the course of the trade’s duration. Hopefully, this post properly explained some of the nuances of this strategy.
If you have questions or comments, leave them down below.
How might one analyze the advantage (or disadvantage) of selling a shorter term (nearer expiration) option versus the examples above where you “straddle the weekend”, selling the trading day before the expiration of the long option? I ask because one would collect more premium over the life of the calendar by selling a nearer term short strike and rolling it out each week. Perhaps more significantly, an increased width in the time spread would allow for realizing greater gains also as a result of an increase in implied volatility, which we we expect when structuring a directional trade to the downside.
Great question JL and I added an update in the post to address it. One thing I’d like you to consider is how would the strategy of rolling the short strike in a Calendar *out* compare to rolling the long strike in a Diagonal *down* to turn it into a Calendar? It’s that type of analysis over the years that has allowed me to develop the option strategies that I share here and on the Twitter feed every day. If you have a chance to compare the 2 strategies yourself you’ll find that it’ll benefit your trading and I’d really like to post the results of your analysis to help others!