By Greg Jensen
CEO and Founder, OptionsANIMAL
Sell in May and go away?
This age-old adage is being thrown around way too often for my liking lately. It seems almost every news source from print to radio to television is questioning whether now is a good time to abandon the market.
Analysts and contributors line both sides of the argument and wax poetic whether it is right to embrace this market or flee from it. This is the problem with being limited to trading only one direction in the market. Most investors rely on stock prices moving higher to make money because they continue to subscribe to the strategy of buy and hold. If an investor is relying on a strategy that only makes money if the market goes up, then I can imagine this is a very difficult time for that investor.
Option trading gives you many choices. I can still engage in this market, and trade wherever this market may be headed whether up, down or sideways. There are many strategies that are available. Uncertainty may require something non-directional like a straddle or a collar trade. Spreads are a type of trade that allow you to pick a direction, but take some of the edge off of the risk in the trade by hedging. One of my favorite spreads to trade markets like this is a call calendar trade.
A Call Calendar Spread trade is a neutral time spread. Unlike the Bull Call and Bear Call Spread trades that involve buying and selling different strike prices with the same expiration month, this strategy involves buying and selling the same strike price with different expiration months.
The long-term option is purchased with the expectation that the stock will trend upwards prior to its expiration point while the short-term option is sold with the expectation that the stock will stay below the same point in the near term, prior to the short-term expiration date. This strategy takes advantage of a stagnant or slow moving up trend. Time decay in the long-term option is offset by selling the short-term option. The short-term option is sold to take maximum benefit from the rate of time decay on the short side. The longer-term option also serves as a hedge on the short-term position.
The Call Calendar is similar to the Covered Call Strategy except that it offers better return on risk and requires less trading capital.
Option - Long Term Long Call
Application - Buy to open an ATM or slightly OTM long-term long call option at the ask price.
Option - Short Term Short Call
Application - Sell to open an ATM or slightly OTM short-term short call option at the same strike price as the long-term call option. The expiration month will be much closer to the current date for the short-term call option than the long-term call option.
As in all other trades mentioned, the primary exit point will control greed. For the call calendar spread trade, you define a primary exit point when the short-term call option expires worthless. Assuming the stock remains stagnant, you can close the long-term call option for a profit. If the trend is slightly bullish, then you can continue to short options against the long-term long call option. Alternatively, you can set your primary exit point as a percent net gain.
The secondary exit point is pre-defined and will control fear. The secondary exit point is essential in generating consistent profits. Again, you can decide the percent loss you are going to define before you execute the trade. Alternatively, you can adjust the trade to a different spread trade to maintain profits. You can easily do this if you understand the options trading instruments. For instance, you could convert the call calendar trade to a bear call in a down trending market.
The Call Calendar Spread is a debit trade. The long call is the primary trading instrument that generates the profits in the trade. The short call limits risk. The trade takes advantage of stagnant or slightly bullish trends.
Option - Call Calendar Spread
● Open Position Primary
○ Buy an ATM or just OTM long call option.
○ Sell a short call option at the same strike price but with expiration date within 30 days.
● Exit Point & Adjustment
○ Decide on the percentage return you wish to make in the trade and set it as your primary exit point.
○ If trend is stagnant decide that you want to capture the entire credit from the short call expiration
○ If trend is slightly bullish you can continue to short call options against the long-term long call option
● Secondary Exit Point and Adjustment
○ Decide on % loss you are willing to accept in event of trend change.
○ Alternatively pre-define what trade adjustments you will make to maintain profit potential