Let's Trade Options

yeah, you've got it. If AAPL runs down below $105 you have to start thinking about exiting the trade if you are within a few days of expiry, because the itm short puts could be assigned. If you are short options, you're obligated to sell them, regardless of whether they are in a spread or not. But I will go into assignment risk later. I'm looking for a good example to show you how I trade calendar spreads around ER's.....

Awesome. Calendars was my next topic for the interrogation. Didn't want to make you work on Saturday though.

no prob, I usually do research on the weekend. Have to go out now and look at a RE project prospect though. Been waiting for it to warm up a bit, 28F here.....envy....

Good luck with it. Your help is much appreciated. I wont tell you what the weather is like here.

ok I will talk about calendars, using an example on GOOGL, which ER's on 1/26. I am looking for a trade to run right up to that date, and at about 6 weeks out, I am where I want to be. This has to do with the implied volatilities (iv's) of the options. Note on the chart I have plotted the iv's of the options. The iv's crash after the ER's and rise in the weeks running into the ER's.

Who cares about iv's? Every options trader, that's who. Since options' pricing is based on iv, you are actually trading iv, whether you know it or not. When the iv's are cheap, you buy options and hope the iv's increase. If the iv increased enough, you could make money on an option even if the u/l didn't move. Typically, though, iv will increase when the u/l price falls, and vice-versa. The iv shown on the chart is (so far as I know) the average of the atm put and atm call iv's in the nearest chain (front week or front month).

in the GOOGL chart, the prior ER dates are where those little blue and red circles are. Iv's rose to that date and crashed after. Let's say I want to bet GOOGL will drop, hard, maybe down to $775 or lower. You can see from the chart that is what happened on other ER dates in the past. So, I will look for a cheap put calendar spread, hope GOOGL slides down into the ER date, and hope the put iv's rise up from the low now (15%) - up to 30% or better.

I am going to try a Jan27/Feb17 $750 put calendar. At $310 a pop I will prolly just buy one. In the P/L graph below, I show the trade at 1 day before the ER, with NO modeled change in iv's...the spread has a maxP about $850 net and is in profit from about $705 to $805:

in this P/L, everything is the same, but I have modeled a 10% global increase for the puts. The MaxP is higher - $1,350, and the b/e's are wider - at $675 and $840. 10% is a pretty big rise in iv's. Note that I am projecting 10% rise not for the iv's of the front week atm options, which is what is shown on the GOOGL chart. Rather, I am projecting a 10% increase in iv for the options that are actually in my trade. So, those iv's are @ about 25% now and I am saying they will be 35% 1 day b4 the ER.

That might be a tall order, so I can model for a 5% rise or even a % loss. The P/L shown here is for just a 5% rise, so iv's around 30%. I see that has been done before right before prior ER's, so 30% is doable. Here the MaxP is $1,100 and the b/e are at $688 and $828.

In this put calendar trade I want two things to happen: I want the GOOGL share price to fall before the ER and I want the put iv's to rise into the ER date. I fully hope to take the trade off on the day before or day of the ER if these things happen. If they don't, and the Jan27 puts expire worthless, I still may have chances to make money with the Feb puts. The calendar just becomes a long Feb17 $750 put after the Jan27 put expires...I have shown the P/L with a 10% drop in iv for the remaining long put and the b/e is at $770. If you don't think GOOGL will move that low in the remaining 3 weeks, you could look to buy another spread on top of the long $750 put - you could buy a bull put vertical on top of it and turn it into a fly, for instance....if GOOGL is trending down but did not quite make it to $750, you can let the front short put expire worthless and wait/see if the trend runs your $750 long put in the money.

If there was a huge move south and GOOGL blew way below the lower b/e of the calendar, you'd have to close it before expiry. If GOOGL blew north away from the upper b/e, you'd do nothing and you'd be left with the long Feb $750 put.

the calendar trade I use above is a specific scenario set up to catch the iv rising into the ER - the ER is a binary event that occurs 4x per year for stocks, so it's good to understand the ways to trade those. There are lots of other ways to use calendars: I will show some more here over the weekend.

Wow. Ok. A lot to digest but put in terms I can understand. I will chew this one for a bit. Thanks for your clear explanation.

How the fool what platform are you using and also do you still do forex options?
im looking for a good stradegy simulator live platform like similar to think and swim but I can find one with good risk reward and stradegy straddle, bear cover etc simulator!!! Can you help me out???

I use the thinkorswim platform from TD Ameritrade. I don't know if you can open an account with TDA, but they will allow US citizens to open an account without funding it.

You can try dough.com, or these guys

http://www.optionsplay.com/

...the latter unattached to a brokerage but I think they charge a monthly subscription fee....

Alright. So the premise with this spread is to play the historical pattern around earnings reports where implied volatility often rises into the event. This rise in iv will help make the puts profitable because iv is the central factor in options pricing so when it goes up, the value of the puts go up. This rise in iv should be accompanied by a drop in the underlying to be max profitable and although not a rule, it's likely you get one with the other.
You are looking at the iv on the underlying via front month atm's when you are picking when to enter, strike, etc. and in the models you run you are looking at the implied volatility of the spread itself.
Profit is highest closing at the strike. South and below the spread, you close and eat the known $310 risk. Profit is potentially lowest if price moves north above the spread but not necessarily. After the Jan expiry you could add legs to the put you own now and make it a butterfly (i.e. sell 2 February 755 puts and buy 1 760) or some other type of spread.
You mentioned a price of 3.10 for the spread. What about the one you sold? Won't 3.10 be offset by that some?
What if you were bullish on Google? Would you set up the same type of spread with calls? Seems like it wouldn't work the same way with iv's correlation to u/l price and all. I guess it would end up being a bet on low volatility and tighter price range, no?
Thanks again

I often trade these ER calendars as double calendars (DC's) and if the iv rises like I hope it will, I end up with a trade that is in profit across a huge range. Adding the calls calendar as shown increases the initial debit, but expands the profit zone.

I need that iv increase. When that does not actually happen, I can get what is shown in the second P/L. The first P/L has a modeled +5% iv rise, the second a 10% drop.

I have had these 2 results shown above happen to me. One of the selling points of options trading is that it is easier to predict iv changes than it is to predict directional moves. I think that is true, but...there are no guarantees. We are living through an epic bull run in the US equity markets and there has been a real shortage of premium (premium = iv). Instances of high iv in the markets are brief and are exploited quickly by a relentless btfd crowd. That could change.....

Anyway, the key to these ER calendar trades is to buy the options when iv is cratered. Yep, the old "buy low, sell high" still applies, only it is applied to iv. You might be looking at buying options a month or more ahead of the ER to catch that bottom. OK, then the options you buy immediately start having their value eroded by the passage of time ... sounds great, huh?

One trick on the ER calendars: pick a stock that has its ER on a Wed or Thurs, just 1-2 days before an opex, because sometimes the best of an iv rise comes on in the last day or so before the ER....so you want that ER rise especially in the day or so before opex.

directional trading with calendars? or vertical call spreads? or just long calls? lets's compare. Let's say you think SPY will keep trending up to new highs after Xmas, maybe to 230 or higher.

You have about $100 to put on this bet. You could buy 8 Dec28 $231.50 calls for $97.x and the trade b/e would be at $231.40 at expiry. A finish at $232.00 would be worth $657 net.

for $105 you can buy 10 Dec28 $$228.5/$229 call vertical spreads. The b/e is at $227.90 at expiry with a a maxP of $420

also for $105 is 10x the Dec28/Dec30 that has maxP of $253 and a b/e of $227.75. I have added comms to the P/E's for all these trades. If I am trying to trade a trending issue I will often use the vertical spreads now. But nothing pays better than long calls - past a certain point it will pay the same as long stock. A disadvantage of the calendar is that a hard trending issue could run beyond its profit zone.

I often use combo's of these spreads and even long options sometimes, but I will touch on that later if you're still interested....one thing that makes the options trading learning curve steep is the sheer number of possibilities you have to trade any given scenario. It takes time/experience to figure out what is the best way to trade and also what is the best way for you in particular.