Out of the Money Calendar Spreads
July 19th, 2011This is Buy Phentermine Yahoo a guest post by Derek Devore, an experienced options trader. Find out more about his OptionBoost Video Training Program at http://optionboost.com
One of my favorite structures when I’m evaluating a Buy Phentermine Yahoo position which is slow moving, but is on its way to Buy Phentermine Yahoo reaching a particular price point, is Out of The Money Calendar Spreads, or Buy Phentermine Yahoo “OTM” Calendar Spreads. In a Buy Phentermine Yahoo Calendar Spread, one is basically selling the “front month” option while simultaneously buying an Buy Phentermine Yahoo option further out in time – both options having the Buy Phentermine Yahoo same strike price. The benefit to this spread is the fact that Buy Phentermine Yahoo you are financing part of what you pay for buying an Buy Phentermine Yahoo option, by the option you are selling in the spread. Lets look at an Buy Phentermine Yahoo example:
Let’s say that Buy Phentermine Yahoo the RIMM was currently trading at 28.00 and I thought it Buy Phentermine Yahoo was going rally back to 31.50 by the end of this Buy Phentermine Yahoo month. In this particular situation, I would look to purchase a Buy Phentermine Yahoo Calendar spread at the 132 strike price by creating the Buy Phentermine Yahoo following structure:
BUY +1 RIMM AUG 31 CALL for $0.99
SELL -1 RIMM JUL 31 CALL for $0.21
As you Buy Phentermine Yahoo can see from the above order, I am purchasing the AUG Call (the month further out in time) for $0.99 and selling the JUL Call (the front month, or the month closest in time) for $0.21. So, collecting the premium of $0.99 and buying something else for $0.99, allows me to Buy Phentermine Yahoo reduce my cost basis of the entire spread to only $0.78 (i.e.; $0.99- $0.21). Now, since we’re essentially selling something against something else we’re buying, we want to Buy Phentermine Yahoo make sure that what we are selling is somewhat “overpriced” compared to Buy Phentermine Yahoo what it has been priced historically. How do we best determine what Buy Phentermine Yahoo is potentially overpriced in the options market?…with “Implied Volatility”!
Implied Volatility
Implied volatility is Buy Phentermine Yahoo a measurement which tries to predict the future volatility (the magnitude of up-and-down movement in a security) in order to Buy Phentermine Yahoo assign a theoretical price value for a certain option. In other words, if the Buy Phentermine Yahoo underlying stock makes huge upswings and downswings, it is said to Buy Phentermine Yahoo be more “volatile”. As expectations of future volatility increases, so does the Buy Phentermine Yahoo implied volatility of a certain option contract, therefore its price generally increases and Buy Phentermine Yahoo vice-versa. Therefore, going back to our Calendar spread example, we want to Buy Phentermine Yahoo sell options that are overpriced (using its implied volatility as a measurement ) in order to buy options which we feel are fairly priced.
Charting Implied Volatility
Charting our two different-month options in a Buy Phentermine Yahoo volatility chart quickly shows us that we are on the right track in terms of selecting this Buy Phentermine Yahoo particular spread. If you notice in the chart below, the light green line (representing the July option we sold) is much higher than the dark green line (representing the Aug option we bought). Furthermore, you Buy Phentermine Yahoo can see exactly where the 31 strike price lies on the Buy Phentermine Yahoo chart, by the brown crosshairs – showing us that Buy Phentermine Yahoo the implied volatility for the Aug option is all the way up to Buy Phentermine Yahoo 49.89%, compared to the 44% implied volatility for the July option.
So it Buy Phentermine Yahoo looks like we have indeed accomplished our goal of selling something which is Buy Phentermine Yahoo relatively “expensive” to finance the purchase of something that is relatively “fair” in price.
Conclusion
Although this Buy Phentermine Yahoo is just one aspect to consider when purchasing Calendar spreads, hopefully it Buy Phentermine Yahoo will inspire you to dig a little deeper into implied volatility charts to Buy Phentermine Yahoo allow you to see in a type of “third-dimension” of how pricing in the Option Market behaves – and more importantly – how you Buy Phentermine Yahoo can learn to spot these pricing instabilities to use them to Buy Phentermine Yahoo your advantage in your trading.
Derek Devore is Buy Phentermine Yahoo an experienced options trader. He professionally trades his own account, from Buy Phentermine Yahoo his home, specializing in Options Trading and Forex. He is the Buy Phentermine Yahoo creator and owner of the OptionBoost Video Training Program at http://optionboost.com
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