Many readers liked the MCD butterfly I posted on Friday. Here’s the link if you missed it:

http://optiongenius.com/blog/mcd-butterfly/

One reader posted an excellent comment that I decided to create a new post about. Here is what he asked:

As of Friday’s close, the 75 fly would cost $3.15 for a BE range of 73.16 76.86. Max profit at the 75 strike (if held to exp day)is approx $180 for a 57% ROI.

With a April/May 75 Calender Call Spread, (with a +1 IV skew),the cost is .83 for a similar BE range: 73.4576.46. Max profit at 75 strike is only $62 (compared to $180 for 75 fly), but the ROI is 75% (compared to 57% ROI for fly).

So here’s the $64 question: given these two ‘range-bound’ option strategies that offers nearly identical BE profit ranges, would it not make ‘more’ sense to go for the 75 Cal, given it’s purported superior Risk/Reward profile, in [...]

Yesterday I added a GLD trade to the OptionGenius.com portfolio and I mentioned that GLD might be a good candidate for a Calendar Spread. Several members emailed me asking to explain how to set up the trade and the parameters so I decided to just post it on the blog. I tried making a video but I am a total non techie and screwed up the video. I got it uploaded to Youtube but everything on the screen is so small you cannot see what I am doing.

Anyway, here are some screenshots of the trade.

GLD Calendar Spread

Breakevens

The trade was to Sell the Oct 125 Calls and Buy the Nov 125 Calls. That sets up a simple calendar. You can use puts or calls, they are interchangeable but the puts are usually cheaper. The plan is to adjust when GLD hits a breakeven. The simplest adjustment is to just [...]

Here’s a quick and easy trade.

Buy Dec 590 Call, Sell Nov 590 Calls for a debit of 10.65 per spread.

If you do just one contract, it will cost you $1065 plus commissions. If RUT does not move much by Monday you should have over a 10% gain. Even if it moves about 8 points either way, you should still have close to a 10% gain.

This is a great trade to papertrade.

RUt Calendar Spread Graph

In my last post I listed a Free Trade on POT which is called a Calendar Spread, also known as a Time Spread.

In that trade we sold the Oct 90 Calls and Bought the Nov 90 Calls.

The trade makes money when POT stays in range around 90. Basically what we want is the Oct option to decay and lose value while the Nov option (which we bought) retains its value. Time Decay quickly erodes an option’s value, especially in the last 30 days. That is why I prefer to put these types of trades on with 30 or fewer days left for the front month.

We enter this trade with a debit meaning we paid for the trade. That is because the Nov option was more expensive than the Oct option because the Nov option has more time premium.  POT also has earnings after the Oct option expires which means that the volatility (value) of the Nov option will be elevated (at least a little more than normal).

What we want is for POT to stay in between the break evens until it gets close to expiration. The Oct option loses value everyday and that is how we make money. During the last few days before expiration the fluctuations in prices can move wildly.  That is why I prefer to be out of this trade before expiration week. But in this trade we put it on pretty late and will have to stay in longer.

To exit a Calendar Spread you have to sell it. Otherwise you will still be holding the back month (Nov) option even if the front month (Oct) expires.

The beauty of Calendar Spreads is that they are cheap to trade, easy to adjust, and can result in large profits – 20-40% is common. You can also keep your losses small.

I got this trade idea from a very smart member. His observation was that POT

was channeling and that it would be a good set up for an income strategy.

The only problem was that earnings are after expiration which is in 10 days.

Earnings could move the stock but it also keeps the volatility of the options

high and that means high premium.  There is also a dividend to be paid on the 15th, which is one day before expiration. A dididend will lower the price of the stock by the amount of the dividend which in this case is 10 cents.

His idea was a butterfly. I decided to do a calendar because it is easier to adjust and share it here.

Buy 1 Nov 90 Call and Sell 1 Oct 90 Call. This trade cost me $315. My breakevens are at 86.14 and 94.40.

I feel this trade will work. But it will have to be held close to expiration. 

If POT gets outside the breakevens, exit the trade. or if you are experienced enough, add another calendar on the side of the brreakout.  If POT stays around 90, stay in as long as you can.