Down the Calendar Spread Rabbit Hole | LEAP Spread on the SPY

in hive-167922 •  last month 

We setup a new Discord channel on the LeoFinance server called Trade Chat, which is where me and a few other curators/active traders are going to drop and discuss our trades in real-time. These trades can be anything on the stock market, cryptocurrencies, etc.

Today, @nealmcspadden and the curators were talking about the markets (as per usual) and Neal brought up a trade idea:

A 2022 LEAP calendar spread on the SPY.

I've never done a calendar spread, but I've got a curious mind and I've been diving down the options rabbit hole lately anyways, why not take a little path down calendar road.


screenshot from my trading account showing the actual trade

Details:

  1. Bought the long dated $340 call which expires in January 2022
  2. Sold the near-term $340 call which expires in August 2020 (53 days till expiration)

The Jan Call option cost $1,600, but since I sold the Aug call for a credit of $0.82, my total cost basis was reduced to $1,518 (1600 - 82 = 1518).

The Strategy

After putting on the trade, I did some research and discussed the general strategy with Neal. I'll reiterate what he told me, since I'm following his lead on this and trying out his style of trading this type of calendar spread:

"for me, calendar spreads are speculative and directional. i'm looking for the long-dated call to go into the money. the short-dated calls being sold are only for basis reduction rather than trying to generate income. there are different approaches to this though. that's just mine" - @nealmcspadden

So the goal with this trade is that my front-month option (the 8/21 call that I sold) will expire worthless in 53 days (or I may close it and take a certain % of the credit and move on to sell the next month). If I just let this expire worthless and keep 100% of the credit, then I'll reduce my cost basis on the $1600 option down to $1518 (as previously mentioned).

Whenever I close this August option, I'll look to sell another option against the long-dated call again with a different expiration date. The credit I collect from that second option will also reduce my cost basis further.

Neal mentioned that in an ideal world, I would collect almost all of the original cost of the long-dated option over the next 18 months as I continue to sell $340 calls with a closer exp. date.

As we approach the 18 month mark, the SPY will hopefully be above that $340 strike and at that point I would have a long Call contract that is in the money and a cost basis that is less than $1,600.

This is a fascinating strategy to me as in the past I've only used options for short-term bets on the market. I would typically go long on some puts or calls that expire within the next ~28 days. Those situations are high risk, high reward.

Lately during the LEO roundtable chats, the guys have been getting me obsessed with these more long-term, lower risk and lower reward trades with high probabilities of success.

This calendar option seems like a great directional bet on the markets. If we reach new all-time highs in the next 18 months, I'm going to be a happy camper. Even if I lose on this trade, I'm glad to get the opportunity to try a calendar spread for the first time.

More experience and more potential tools to add to my disposal are never a bad thing.


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Interesting play. In some ways this is like Synthetic Covered Call. Instead of buying the stock, you buy the call. Then you sell shorter term options which are backed or covered by your synthetic position. As you mentioned you can do thus every week or month, you pick the term. I look forward to reading how this turned out.

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