Think of your big-tech players and companies like Apple stock, Tesla stock, Microsoft stock and Alphabet stock certainly come to mind. Something else these stocks have in common? We are currently seeing the lowest level of implied volatility in these names over the last 12 months. Here’s a way to take advantage with a double calendar spread.
How To Profit At Low Volatility Extremes
When implied volatility drops, it’s fantastic for existing short volatility trades. Short volatility trades (sometimes called negative Vega) do well when implied volatility drops after opening the trade. Falling implied volatility makes it tough to find new opportunities, until you start getting to extremes.
Long volatility trades (sometimes called positive Vega) do well when implied volatility rises after opening the trade. Long volatility strategies include long straddles and strangles, calendar spreads, and backspreads. For Apple stock, we’ll take a look at how to set up a calendar spread. This is an advanced trading strategy, so it is not recommended for beginners.
For a calendar spread, you sell an option and buy an option at the same strike price but with different expiration dates. Here’s how you could set it up for Apple stock using the closing prices from yesterday:
Apple Stock Double Calendar Spread Setup
We could use the Aug. 27 expiration for the options we sell in this case. And we’ll set it up with five contracts. Yesterday, you could sell the 135 puts at 0.30 and the 155 calls at 0.20 for Apple stock.
Our long options would use the Sept. 10 expiration. The 135 puts traded at 0.69 and the 155 calls were at 0.60. Both are long and short puts are at a strike price of 135. Our long and short calls are at 155. The different expirations make it a calendar spread.
Effectively, we are creating two profit zones around 135 and 155. The assumption is that AAPL stock might move into one of those areas in the next two weeks.
The trade also has positive Vega, so it will benefit from a rise in volatility.
The capital at risk is limited to the amount paid. Calculate this by starting with the amount paid for the Sept. 10 options (since you are buying these, you pay premium). Then, subtract the amount received for the August 27 options (these are the ones you are selling).
For the options bought on AAPL stock, you add the 0.69 and 0.60 to give you 1.29. Multiply that by 100 shares per contract and five contracts equals $645 paid.
For the options sold on Apple stock, you add the 0.30 and 0.20 to give you 0.50. Multiply that by 100 shares per contract and five contracts equals $250 paid.
Taking $640 less $250 gives a total capital at risk of $395.
One thing to watch out for is assignment risk if AAPL stock breaks below 135 or above 155.
Let’s see how this one progresses. If calendar spreads are new to you, it’s best to paper trade the strategy first to see how it works before risking live capital.
Remember options are risky. Investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions. Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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