COLLECT THETA AND EXPRESS A MARKET BIAS
MARKET-NEUTRAL STRATEGIES earn a profit when time passes and the "magic" of time decay (Theta) does its thing. Of course it is not as simple as opening a position and waiting for the profits to accumulate. There is always the possibility of a profit-destroying price change in the underlying stock or index.
Nevertheless, these strategies work well when the markets trade within a narrow price range. The beautiful characteristic of these versatile option strategies is that they can be used by the bullish or bearish investor as well as by the market-neutral trader.
LET'S EXAMINE THREE STRATEGIES.
CALENDAR SPREAD
ABCD is currently trading at $65 per share. Believing that the stock price will rally towards $70 as the December 18, 2015 options expiration date approaches, you buy an out-of-the-money calendar spread.
Traditionally, the calendar is used by traders who believe that the stock price will remain near $65 when a specified expiration date arrives.
But there is no reason why it cannot be used by traders who believe that the stock price will differ at expiration. One advantage of using the OTM calendar spread is that it is less expensive than an ATM (at the money) spread.
Example:
Buy 6 ABCD Jan 15 '16 70 calls
Sell 6 ABCD Dec 18 '16 70 calls
As times passes and the stock moves towards $70 per share, the position becomes more valuable and you earn a profit. That profit is maximized if the stock is almost exactly $70 per share on Dec 18, 2015. At that time (or earlier if you wisely do not attempt to earn the maximum theoretical profit) you close the position by selling the calendar spread.
If the stock price does not conform to your expectations, then the spread will lose value as the December calls expire (and become worthless).
You can keep your Jan calls, hoping for a miracle, but it is often wise to sell the call and recover some of the cost of buying the spread.
NOTE: One factor that affects profitability is volatility. When implied volatility is relatively high, the profits are even larger than anticipated. When implied volatility is low, the profits are reduced.
MARKET-NEUTRAL STRATEGIES earn a profit when time passes and the "magic" of time decay (Theta) does its thing. Of course it is not as simple as opening a position and waiting for the profits to accumulate. There is always the possibility of a profit-destroying price change in the underlying stock or index.
Nevertheless, these strategies work well when the markets trade within a narrow price range. The beautiful characteristic of these versatile option strategies is that they can be used by the bullish or bearish investor as well as by the market-neutral trader.
LET'S EXAMINE THREE STRATEGIES.
CALENDAR SPREAD
ABCD is currently trading at $65 per share. Believing that the stock price will rally towards $70 as the December 18, 2015 options expiration date approaches, you buy an out-of-the-money calendar spread.
Traditionally, the calendar is used by traders who believe that the stock price will remain near $65 when a specified expiration date arrives.
But there is no reason why it cannot be used by traders who believe that the stock price will differ at expiration. One advantage of using the OTM calendar spread is that it is less expensive than an ATM (at the money) spread.
Example:
Buy 6 ABCD Jan 15 '16 70 calls
Sell 6 ABCD Dec 18 '16 70 calls
As times passes and the stock moves towards $70 per share, the position becomes more valuable and you earn a profit. That profit is maximized if the stock is almost exactly $70 per share on Dec 18, 2015. At that time (or earlier if you wisely do not attempt to earn the maximum theoretical profit) you close the position by selling the calendar spread.
If the stock price does not conform to your expectations, then the spread will lose value as the December calls expire (and become worthless).
You can keep your Jan calls, hoping for a miracle, but it is often wise to sell the call and recover some of the cost of buying the spread.
NOTE: One factor that affects profitability is volatility. When implied volatility is relatively high, the profits are even larger than anticipated. When implied volatility is low, the profits are reduced.