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Option Tip
SPY Calendar Spread



Tuesday, October 04, 2011

SPY logo

The option tip for today is based around the S&P500 as represented by the S&P 500 SPDRS (NYSE:SPY) which has rallied back into the channel it has recently been following before reversing near the $120 level. This was just above its 20-day moving average and almost within reach of its 50-day moving average. However, SPY never seriously challenged its most recent highs near $122.50 before heading lower.

Price action in SPY remains consistent with a weak environment, and as we can see from the chart, SPY has been range-bound for several weeks, fluctuating in a range between $112 and $120, and right now it is resting even lower than the end of that range. The option tip at this time, that needs consideration, is placing the spread that I am about to suggest, but first, you need to make your best bet as to where the stock will be trading at the close of business on Friday.

SPY-09302011



Your chances of picking the right strike price are about as good as picking the right horse in a horse race, but the good thing about the calendar spread is that if your horse comes close to winning (i.e., the stock closes not too far away from your strike price choice), you can also be a winner.

When you buy a calendar spread, the maximum gain comes when the stock ends up at precisely the same price as the strike price of your spread. At that price, the short position expires worthless (or very near to it) and the long side will have more time premium than any other option in that expiration series.

Suggestion:

Therefore, once you have made your best bet as to where the price of SPY will be next Friday, according to the option tip is to place this spread on this trade:

BTO (buy to open) 1 SPY Oct-11 115 call (SPY111022C115)

STO (sell to open) 1 SPY Oct1-11 115 call (SPY111007C115) for $1.80 (buying a calendar spread)

This option tip suggestion is for the 115 strike (you might select a higher or lower strike). If you select a strike of 112 or higher, I would recommend using calls: or, if lower than 112, use puts, although mathematically it makes no difference.

The $1.80 price is what you would have had to pay last Friday. It will probably be less than this if you place the trade today or tomorrow.

You will have two opportunities to get your investment back (and hopefully, more). The first will come on Friday (October 7). You will buy back the call you sold short and sell the next-week call at the same strike.

This is the trade you could make then:

BTC (buy to close) 1 SPY Oct1-11 115 call (SPY111007C115)

STO (sell to open) 1 SPY Oct2-11 115 call (SPY111014C115) for $ (selling a calendar spread)

At last Friday's closing option prices, if the stock is trading between $113 and $116, you would be able to sell this spread for a minimum of $180. You would have all your money back, and when you made this same trade a week later (on October 21), anything you received from the sale would be pure profit.

A further option tip, involves an alternative move, which would be to close out the original calendar spread on October 7 rather than rolling over for another week. If the strike you selected was within $3 or $4 of the stock price on that day, you should be able to sell the spread at a profit.

This little option spread might be a way to get your feet wet in the options world, and you would learn a little about how calendar spreads work without having to wait very long to see the results. The closer your selected strike price is to the stock price when the short options expire, the greater your return.



”Success is simple. Do what's right, the right way, at the right time.”



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