Setting Up Directional Calendar Spreads

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Calendar spreads: In today's video, we're going to cover all of the trades that we made on Friday, January 23rd, but it is Saturday, so I'm doing this video over the weekend as always. It was just a very quiet day, I guess, with just a couple iron condor trades that we're adding and we're going to talk a little bit about stacking trades and/or laddering trades, whatever you want to call it, however, you want to say it, and we're also going to talk about a couple of calendar spreads that we entered in Starbucks and Intel. 

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To kick off the night here, let's talk about our first trade in FXI. Now this is an additional trade to the one that we already have for February. As I mentioned in the trading alert on Friday, this is not an adjustment of any kind. We still have the February iron condor in FXI but implied volatility remains high, and FXI is very liquid so we went ahead and added another iron condor, kind of stacked one on top of each other so we have an Iron Condor in February and we also have one now in March.

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For the iron condor in March, we decided to go about 20% out of the money on each end at the time that the stock opened. We did the 46/47 CALL spread and the 38/37 PUT spread below the market, took in about a 30 cent credit. We go to our broker platform here; you can see that the stock rallied just a little bit towards the end of the day but our PUT side's again down here around 38/37, and then the CALL side is up here around 46/47.

You can see that what's really good about FXI right now is that it's got a lot of liquidity and it's got a very deep market. There's a lot of different strikes to choose from, and pretty much all of the strikes have a lot of liquidity. We did decide to go with the 38s which were a little bit lower on the PUT side because there was so much liquidity in that strike. It was just very easy to get into and out of that trade. There shouldn't have been any problem with everyone getting into or out of these trades. Again, what we're looking at here with FXI-

Let me just change this to our base charts here. We are looking to see implied volatility continue to drop. It's at the 58th percentile; the stock's just a little bit up as far as it's just had a continued rally. What we want is we want not only just a slight drop or decay or sideways movement from here to February but also as we start getting towards March expiration.

As far as our next iron condor goes, we did the same thing with FXI in USO. We already have an iron condor in USO for February. Again, implied volatility remains high in oil. Oil has still been a highly liquid market to trade right now as it continues to sell off and we're going to continue to add these iron condors. They're a high probability of success trades, very good to get in and out of, very liquid markets.

For USO we decided to trade the 20/22 CALL spread, so a $2 wide CALL spread and the 14/12 PUT spread below the market for a 47 cent credit. Only did one of those contracts took in 47 cents. Again, here is a chart of USO. You can see the stock's still selling off and implied volatility's at the 99th percentile. It's about as high as it's been in the last year.

You can see it's been about that high over the last couple of months, so it's not to say that oil can't continue lower. It could continue lower, or it could bounce back, but we're just playing the high implied volatility, continuing to make more and more of these trades. Again, with USO we're just stacking this trade right on top of the February position that we already have.

You can see we already have that February position, that's getting a little bit too close to add another trade to so now we're going out to March, about 55 days out adding this trade. You can see we targeted it at about the 18% probability of success on either end and implied volatility went up just a little bit towards the end of the day, so these numbers are a little bit inflated, but we were trying for about the 15-18% probability on each end, and you can see exactly where our positions are. This would be a good trade for heading into March, but we do need some stabilization in oil.

Two calendar trades that we added today, and I like these calendar trades because one, we needed some calendar trades in our portfolio, we didn't have any and this is something that I mentioned to premium members the other night on our strategy call this weekend is that we needed a couple more calendars just to even out the portfolio. We've got a lot of short premium in volatility, we also need a little bit of long premium in volatility, and we can do that with some calendar spreads.

The first one that we decided to enter is in Starbucks, and again with these calendars, remember that we're selling the front month which is February, and you buy the back month which is March. I know it's a little bit confusing, we've got a great video tutorial on how to build these calendars right inside the membership area, so check it out in the strategy section. We decided to do the 85 PUT calendar for a 70 cent debit.

Remember, with these calendars; you can get a little bit directional by trading either the PUT or the CALL. In Starbucks we did the 85 PUTS, so we're getting a little bit directionally bearish on the stock. With Intel, we did the 38 CALLS, so we're getting a little bit directionally bullish on the stock, and that's exactly how you would do it. You would trade the PUTS if you're bearish or slightly bearish, and you trade the CALLS if you're slightly bullish.

Both of these stocks did go through earnings and had a nice drop in implied volatility. With Starbucks, you can see the stock made a huge move, definitely well outside the expected range, so I'm glad we didn't trade it for earnings because it was a stock that moved more than two times its expected range, but you'll see that implied volatility dropped like a rock.

In this case, we're playing just the rebound or kind of the pullback here from the stock and the gap. Usually what happens is when these stocks have a huge gap like this, they tend just to pull back a little bit as they head towards that front expiration month, and again, that's just because people are at this point are going to start selling their stock because they've been holding it for the last year anywhere between 76 and 82.

Now they can sell it at 88, they'll likely start to maybe dump a couple of shares, and that may cause the stock to come back, and again, that's just how we're playing it. When we look at the profit and loss diagram here, with Starbucks, you can see that we are directionally bearish on this trade, we don't make money right here where the stock is sitting, we need the stock to move down inside of basically 87 to 83.

We've got a nice wide window of opportunity here to make money, but we do need the stock to move down between now and expiration. With Intel, we are doing the opposite. We're playing Intel a little bit directionally higher. Intel also had earnings last week, the implied volatility's dropped, so it's low in the 25th percentile, that's great for this type of trade. We want to be long volatility with these calendar spreads, and with Intel all we're doing here is just maybe assuming that at some point the stock has a little bit of a breakout here.

We need a couple of bullish positions in our portfolio, and so with a little bit of a bearish tilt towards Starbucks. We're going to be a little bit of a bullish tilt towards Intel. Maybe the stock breaks out, maybe it doesn't, but that's the way that we're going to play it. It's just a very small bet anyway so we're not too concerned about it. Again, you can see this is the profit and loss diagram here for Intel. We're directionally bullish on Intel.

We need the stock to move up to at least 37 before we start making money, but we can make money anywhere between 37 and 39. We've got a pretty good risk to reward ratio here; it's about one to about one and a half as far as that goes. Again, very small trade, it's only a $30 trade. This is a great trade if you have a smaller account because it doesn't take up a lot of capital, you can get directional in the market, and you can also play low implied volatility.

As always, I hope you guys enjoy these videos, if you have any comments or questions, please ask them right below, and until next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.