As I mentioned in this article, understanding what you are getting into is half the battle in option trading. Let’s extend that by taking a look at some example hypothetical trades using options on Boeing (ticker BA).
Ticker BA
As you can see in Figure 1, in the long run BA has been a stellar performer.
Figure 1 – BA Monthly (Courtesy AIQ TradingExpert)
In Figure 2 however, we see what makes markets interesting. One person might look at this chart and see a stock forming a head-and-shoulders top and which may be due to break down. Another person might look at this chart and see a stock trying to hold at support in the $300-$320 a share range and which is due for a bounce back up towards $400.
Figure 2 – BA Daily (Courtesy AIQ TradingExpert)
The example trades below are for the person who wants to bet on the latter. Remember that the first alternative would be to buy 100 shares of BA, however, that comes at a cost of $33,200.
Calendar Spread 1
The first example is an out-of-the-money call calendar spread which involves:
*Buying 1 May15 350 call @ $13.55
*Selling 1 Mar20 350 call @ $7.75
Figure 3 displays the risk curves for this trade.
Figure 3 – BA May/Mar 350 call calendar spread (Courtesy www.OptionsAnalysis.com)
Key things to note:
*The trade costs $616 to enter
*The profit range is roughly $326.59 to $376.11
The key things to be aware of are:
*If BA rallies sharply right away this trade will not participate (see the red risk curve line in Figure 3 which represents the risk curve as of the current day). As you can see by looking at the risk curves in Figure 3 this trade takes time for profits to develop.
*If BA declines in price some sort of stop-loss action may be required, so a trader would need to have a stop-loss point in mind when he or she enters the trade.
Calendar Spread 2
The second example is a further out-of-the-money call calendar spread which involves:
*Buying 1 May15 380 call @ $5.45
*Selling 1 Mar20 380 call @ $2.21
Figure 4 displays the risk curves for this trade.
Figure 4 – BA May/Mar 380 call calendar spread (Courtesy www.OptionsAnalysis.com)
Key things to note:
*The trade costs $353 to enter
*The profit range is roughly $343.18 to $421.84
The key things to be aware of are:
*Despite the higher breakeven point at option expiration in March, if BA rallies sharply right away this trade WILL participate. As you can see by looking at the red risk curve line in Figure 4, if BA somehow managed to hit $380 a share today (not likely, but for illustrative purposes), this trade would have an open profit of roughly $215 (or roughly 60%).
*If BA declines in price some sort of stop-loss action may be required, so a trader would need to have a stop-loss point in mind when he or she enters the trade.
For what it’s worth, just below the recent low of $320.61 looks like a viable stop-loss candidate. These trades are essentially a bet that the recent low would hold, if it does not and the basis for the trade evaporates, it makes sense to “cut bait”.
A 3rd Choice
By now, an avid options trader has in his or her own mind, likely developed a “preference” between the two choices above. But consider one more alternative – i.e., taking BOTH trades simultaneously.
The particulars for this combined trade appear in Figure 5 and the risk curves in Figure 6.
Figure 5 – Combined Calendar Spread particulars (Courtesy www.OptionsAnalysis.com)
Figure 6 – Combined Calendar Spread risk curves (Courtesy www.OptionsAnalysis.com)
Key things to note:
*The trade costs $969 to enter
*The profit range is roughly $331.80 to $402.06
Assuming:
*That BA continues to hold above recent support near $320, and;
*That the trader is patient and willing to let time work in his or her favor
Then:
*Between $332 and $400+ a share for BA, this trade essentially gains value every day thanks to its positive Theta Greek value)
The Final Iteration
For the record, the final example below (in the case of a high-priced stock like BA) requires a much greater $ commitment, but it is for illustrative purposes only. This iteration involves:
*Buying 5 BA May 350 calls
*Buying 5 BA May 380 calls
*Selling 5 BA March 350 calls
*Selling (ONLY) 4 BA 380 March calls
In other words, we trade a 5 lot (which obviously increases the financial commitment and $’s at risk) BUT we only sell 4 of the $380 March calls.
Why? To “open-end” the upside. In Figure 7 we see that:
*Cost to enter is $4,741 (again, this is due to the high-priced nature of BA stock and option prices)
*The KEY THING to note is that this trade is profitable at any price above $332.80 a share at March option expiration.
Figure 7 – BA Combined Calendar Spread (selling one less OTM call to “open-end” profit potential) (Courtesy www.OptionsAnalysis.com)
Summary
Is any of this worth doing or even knowing about? That’s for each option trader to decide.
Jay Kaeppel
Disclaimer: The information, opinions and ideas expressed herein are for informational and educational purposes only and are based on research conducted and presented solely by the author. The information presented does not represent the views of the author only and does not constitute a complete description of any investment service. In addition, nothing presented herein should be construed as investment advice, as an advertisement or offering of investment advisory services, or as an offer to sell or a solicitation to buy any security. The data presented herein were obtained from various third-party sources. While the data is believed to be reliable, no representation is made as to, and no responsibility, warranty or liability is accepted for the accuracy or completeness of such information. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Past performance is no guarantee of future results. There is risk of loss in all trading. Back tested performance does not represent actual performance and should not be interpreted as an indication of such performance. Also, back tested performance results have certain inherent limitations and differs from actual performance because it is achieved with the benefit of hindsight.
