[Music]
what's up everyone welcome back to Mike
and his whiteboard my name is Mike this
is my whiteboard and if you're brand new
to this segment we break down concepts
and we construct them visually for you
so we've got over 60 about 65 episodes
now in the tastytrade archives so if you
missed any of them definitely check them
out at the top of tastytrade just go to
fine shows scroll down to Mike and his
white board and you'll see all of them
there ranging from beginner option
concepts to intermediate strategies
we've got them all for you
and today we're gonna step back a little
bit and take a look at a beginner
strategy and it's the calendar spread so
we're looking at the calendar spread and
different scenarios we might use this in
we're gonna take a look at the risk
profile graph we're gonna see how it
works and what we can calculate from it
so let's get right into it and we'll
break down exactly how we construct a
calendar spread so right here we can see
that a set up in a calendar spread for
an example we've got a strike price of
100 as you can see here and basically a
calendar spread is the combination of a
long option in a further dated
expiration with the combination of
selling that same strike same option in
a near term expiration so in this
example we're looking at purchasing the
April call at the 100 strike and we're
looking at selling the Feb call against
that on the same exact strike and what
we're gonna find is that calendar
spreads are going to be routed for a
debit which means that the most I can
possibly lose on this trade is the debit
I paid for that so as we know with a
long call the max profit is going to be
unlimited to the upside we know that
we're paying for this option so my
breakeven point is going to be way over
here it's not going to be really
anywhere near the strike price because
of the fact that if I pay for an option
to hold that write to buy 100 shares of
stock at a certain strike whatever I pay
for that I have to add that value to the
strike price to get my breakeven because
at the end of
day at expiration if I pay $5.00 for
this option I need to sell this option
for $5.00 to break-even on that trade
and the only reason I can the only way I
can do that at expiration
is if this strike is 5 points in the
money so in that example if I've bought
the 100 call for $5.00 I would need this
little blue thing the stock price here
to go up to 105 so that's my break-even
point but since I've got no cap to the
upside
I've got unlimited profitability with
just this long call here however when I
look at just a short call it's the exact
opposite as you can see my profit is to
the right on this strike bar with the
long haul but my profit is to the left
with a short call as we know with a
short call we can profit to the tune of
whatever we collected in premium for
that so in this example I'm looking at a
February call and regardless of what
that value is my profit is going to be
to the left of that strike bar I want
that stock price to go down when I'm
looking to sell the call and that's
going to leave that call out of the
money which is going to allow me to keep
the credit I received as profit at
expiration because as we know options
cannot be exercised for anything other
than intrinsic value at expiration so
when we look at these two separately we
can see the different basic profiles and
the risk crafts associated with them but
it gets a little trickier when we
actually combine these two options so
let's go to the next slide and we'll
take a look at what that looks like so
when you look at a calendar spread risk
profile you're going to see a little
something like this
so we know that we paid a debit for this
so my max loss is going to be down here
so if you can imagine the verdict or the
horizontal strike here as being our
breakeven point we're looking at
basically a profit or loss along this
line as you can see my max profit is
going to be received if the stock price
is right around the strike price at
expiration and it's going to be most
important and most helpful if volatility
in fact increases and we'll talk a
little bit more about that in just a
second
but as you can see the risk profile
graph flattens out to the right and
flattens out to the left so we're going
to talk a little bit about why that is
so let's say the stock price ends up
drifting all the way to the left so we
would have two out of the money options
both which would expire worthless
however we did pay a certain amount for
this option we paid a debit for this
spread because we know that if I'm
buying an option further out in time and
I'm selling an option to reduce my cost
basis against that regardless of
whatever I'm selling this option for
this longer option is going to have more
value if we think about it in terms of
life insurance or car insurance the
longer time frame I'm insured for the
more premium in total I'm going to have
to pay for that it's the same thing here
if I'm selling an option it's going to
be worth less than another option I'm
buying that has double the amount of
time or triple the amount of time or
whatever it is because of the fact that
with the long option I have much more
time to be correct and for that I'm
paying more of a premium to do so so if
the stock price goes all the way down to
the left there we know that I paid a
certain premium I paid a debit to
execute this calendar spread so if the
stock price goes down and these options
are completely out of the money I would
lose that value and that's the most I
could possibly lose however if the stock
price goes up it's a little bit
different so we know that we paid a
debit for this spread but if the stock
price goes up too far it can in fact
become a full loser and that's because
of the fact that I've got the winning
option here so my long haul would
definitely show profitability on this
trade however my short call at the
expiration of this expiration is going
to be capping my profits on my long call
so we know that there's intrinsic value
associated with in the money options so
whatever my intrinsic value profit is on
this call it's going to be offset by
intrinsic value losses with this short
call so the further away we go from the
stock price on either
side here is going to result in a loss
so that's really important to understand
with calendar spreads and that's why we
consider these to be pure volatility
plays so let's go to the next slide and
we'll talk a little bit about how we can
calculate some things with this spread
so I've got some examples here with some
prices so let's say I went out and I
looked at the April calls and I'm
looking at purchasing this call for $7
as you can see it's just out of the
money and I'm looking at selling a
February call against that for $2 as you
can see as we were talking about before
the pricing and the Feb call is much
less than the April call because the
April call has more time associated with
it and therefore it must be priced
higher than that Feb call so the net
cost here is a $5 debit if I'm paying $7
in collecting $2 in premium to offset my
cost basis and increase my probabilities
on this specific trade then my overall
result is going to be a $5 debit so
let's take a look at the bottom rows
here so we've got max profit lifts
listed we've got our breakeven listed
and we have our max loss so the only
thing I have filled in here with this
specific spread is the max loss and
that's because of the fact that we have
a long in April that has a different
expiration than this fab option now if
we were to look at the intrinsic value
of both of these options at the Feb
expiration we can probably come up with
a rough estimate of what our max profit
might be and what our breakeven might be
but because of the fact that we're going
to have this long April call at
expiration especially if this February
call expires out of the money it's
really hard to determine our breakeven
and Max profit so let's talk a little
bit about why that is so if we've got
our April call at the 100 site strike
that we talked about before let's say
the stock price is at 99 right there and
we've got our February call on that same
exact 100 strike let's say that implied
volatility jumps up 20 percent so the
stock price doesn't move at all but
something has happened within the market
and option prices are
increasing for whatever reason which is
going to result in an increase in
implied volatility because at the end of
the day implied volatility is just a
reflection of what's happening in the
option market prices if the prices are
being bit up by a lot of activity and a
lot of buyers of those options it's
going to reflect in an increase in
implied volatility and vice-versa is
true if implied volatility is decreasing
if we see that the IV is decreasing it's
indicative of option prices decreasing
as well so people might be selling a lot
of those options as opposed to buying
them regardless let's say our
volatilities increase 20% but our stock
price has not moved at all so what would
happen at expiration well we would
probably see a marked loss for sure on
the February short call as we know if we
sell an option at a certain value and
implied volatilities increasing which is
indicative of option prices increasing
we're going to see a marked loss on the
February option however at expiration we
can exercise and the option is going to
be worth the intrinsic value for one
minute before expiration it's going to
be trading for pretty much fully
intrinsic value and as we know anything
above the stock price with calls is
considered to be out of the money why
would someone buy shares at a higher
price with a long call when they can
just buy shares in the market for a
lower price they wouldn't which is why
it's considered to be out of the money
so if we know that we'll see a marked
loss if implied volatility increases
throughout the life cycle of this trade
in the fehb call what's going to happen
at expiration all of that marked loss is
going to disappear the Feb call is going
to disappear as well I'm going to be
left with that $5 net debit price but
I'm also going to be left with a long
April call worth a certain value and
because of the fact that we can't
predict what implied volatility will be
and how that's going to affect this
certain option because of the fact we
can't predict the implied volatility
we're not going to really know what our
max profit is and because of the fact
that we're going to have that long call
and if our short call expires out of the
money we're left with a long call with
an unknown volatility value until we're
actually
at that point so we're not going to be
able to really know what this call value
is going to be worth maybe it'll be
worth a little bit more maybe too much
time would have passed where it'll be
worth the same value but even in that
case if I can go ahead and sell this
call for $7.00 if it's worth the exact
same value it's still a profitable trade
because this feb call would have expired
out of the money and worthless for two
dollars I would have paid a $5 debit and
now I can go back into the market sell
this call for seven dollars and that
would net me a two hundred dollar profit
or a $2.00 profit in the options world
so it's really interesting to consider
what the possibilities are with calendar
spreads but let's go to the next slide
and we'll wrap it all together with some
takeaways for you so the very first
takeaway is super important and it's the
fact that a calendar spread is an IV
expansion play you'll see Liz and Jenny
rout these a lot when the volatility in
the markets and volatility and certain
underlyings is really really low because
we're looking for in IV expansion we
want to usually get into this trade when
an IV environment is super low that
gives us the ability to have an
assumption that IV might increase in the
near future as we've shown that IV does
have some mean reverting properties next
on the list is put first call calendar
spread when should I use one when should
I use the other well for me I like to
consider what I'm more comfortable with
being out of the money so if I'm more
comfortable with the stock price
dropping and having my strikes be out of
the money or stay around a range where
I'm holding some call calendar spreads
then maybe I'd look to do a call
calendar spread or maybe if I assume
that the stock price might drift up a
little bit in the near term
maybe I'll go with a put calendar spread
the cost should be roughly the same when
you're looking at the difference between
the put versus call calendar spread
while there is a volatility skew in most
underlyings where the puts do trade at
richer than calls when you're looking at
just out of the money options it's still
pretty going to it's basically going to
be roughly around the same price so
there shouldn't be any true arbitrage
value there so really I would consider
what you're more comfortable with in
terms of being out
money with whether that be calls with
the stock price drifting down to the
downside or with puts where the stock
price might drift up to the upside of it
and lastly IV change effects
longer-dated
options more I was talking about that
marked loss in the February call but
when we're looking at IV expansions yes
we will see a marked loss on the
shorter-term call because we sold it at
a certain value in a low IV environment
and if IV increases I'm probably gonna
see a marked loss on that but since IV
change affects longer-dated options more
my profit that I would see on that long
call is going to offset the short loss
that I'm going to see on that short
option so there's going to be a greater
gain on the long option then I would see
in my short option that I'm going to see
a loss in so basically the difference
between the two is going to create a
profitable scenario if IV does expand so
this has been an overview of a calendar
spread thanks so much for tuning in
hopefully you enjoyed it if you've got
any feedback or questions that all shoot
me an email at support at doe comm
support at tastytrade comm or you can
shoot me a tweet at tow trader Mike
until next time we will see you again
but we've got shadow traders up next so
stay tuned
you