Consider Using Weekly Options in a Calendar Spread

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Dr. W. Edward Olmstead

Olmstead Options Trading Strategies

 

 

The basic goal of a calendar spread (also called a horizontal spread) is to sell a near-term option to collect premium in order to lower the cost basis of a longer-term option with the same strike price. The calendar spread can done with either calls or puts. The basic concept for this trade to be profitable is that the near-term option will lose all of its time value while the longer-term option retains a significant portion of its time value. Unfortunately, the profitability of this strategy also requires the price of the underlying stock to be sufficiently close to the common strike price as the near-term option reaches its expiration date.

 

In the traditional version of the calendar spread, a front-month option is sold against a more distant monthly option with the same strike price. Holding this version of the trade for several weeks while waiting for the front-month option to lose its time value can become very frustrating as you watch the price of the underlying stock drift far from the common strike price into a range that is likely to produce a loss at expiration.

 

Now that weekly options have become available on many stocks (and ETF’s), there are new opportunities for the calendar spread trader. It is no longer necessary for the near-term option in a calendar spread to be the front-month option. The short, near-term option could be a weekly option that expires in nine days or less. While a smaller premium is received from selling a weekly option, there are some compensating features that make this new version of a calendar spread worthy of consideration.

 

By selling a weekly option, the opportunity to exit the trade arrives much sooner. When all of the time value in the weekly option has quickly decayed to zero, very little time value will have been lost in the long-term option. This offers the possibility of a quick exit for a profit that might be small, but also frees up capital to move on to a new trade.

 

Even though a smaller premium is received from selling the weekly option, the possibility of repeating the process over 3-4 weeks could easily provide a total premium in excess of that received from the one-time selling of a front-month option. Here again there is the opportunity to close the trade at the end of any week in which it appears unwise to continue holding the long position.

 

With a weekly option as the near-term component in the calendar spread, it becomes easier to convert the calendar spread into a diagonal spread. As one weekly option expires, it may be advantageous to roll into a new weekly option with a strike price that is further out-of-the-money. This might open up the opportunity for a bigger long-term profit if the price of the underlying stock keeps moving in a direction that favors the long-term option.

 

There are currently well over 100 stocks and ETFs that trade weekly options. Popular stocks that have weekly options include, AAPL, AMZN, FB, GOOG, JNJ, QCOM and YHOO. Heavily traded index ETFs with weekly options include DIA, IWM, QQQ and SPY. Your broker should be able to provide a complete list.

 

 

Dr. Olmstead can be found at http://www.olmsteadoptions.com, an on-line options trading site, centered around options education material and option trading strategies he’s developed. He is Professor of Applied Mathematics at Northwestern University, author of the popular and highly-praised options book, Options for the Beginner and Beyond (2006) and former chief strategist for The Options Professor on-line newsletter, distributed by Zacks.com and Forbes.com.