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01 June 2016 at 10:06 GMT
Background on calendar spread
The technology-heavy Nasdaq 100 index has rallied recently, and we expect the shares to stabilise near current levels. For the following calendar spread strategy using the Power Shares Nasdaq 100 ETF (QQQ) we need the shares to trade near our strike price.
Source: Saxo Bank
A long call calendar spread consists of a farther-dated long call and a near-term short call, such as July/June. The strategy is also known as a "horizontal" spread as it involves options with the same strike price, but different expiration.
There are a few factors to consider with this strategy.
If the underlying price remains steady or declines during the life of the shorter-dated option, that option will expire worthless. This would leave us owning just the longer-dated option. At that point, we could decide to sell another option against it and collect on more premium.
The strategy carries a positive vega and an increase in volatility will be beneficial to the spread. The VIX volatility index is currently trading near extreme lows, so we would be strategically positioned if the volatility starts to expand.
In addition to the positive vega, the strategy also benefits from positive theta and will benefit from passage of time. The Q's provide weekly expirations so we will have an opportunity to roll 4-5 times.
Management and risk description
With a long calendar, the risk is limited to the amount of premium. An early assignment is possible if the short option gets into the money, but we would be covered by the long call with farther expiration.
Trade within your risk limits, for instance, 1-2% of account value.
Underlying price: $110.34
Buy +1 July 16 111 Call at $1.69 (44 days to expiration)
Sell -1 June 16 111 Call at $.86 (16 DTE)
Net debit $0.83
Maximum risk (at expiration): premium paid, or $0.83
Maximum profit (at first expiration): $80
* opportunity to sell more premium which would increase the profit potential
Entry: today at the US open, as two separate orders (Buy Call to Open and Sell Call to Open)
Stop: No stops
Target: ETF to trade near $111
Time horizon: 16 + days
— Edited by John Acher
Non-independent investment research disclaimer applies. Read more