Note: This is not an “investment” position – it is a short term trade for income.
I realize that most members reading this site are not interested in trading Options – so this post is not for them. However, I know that a few members do have an interest in Options so this post will follow a one week trade designed to generate a little income. This is what I do when my portfolios are in cash and I want to try to generate a little money – it is certainly not intended to be a recommendation for “investors” since it needs a lot of attention day to day and could represent too much risk for “traders” not prepared to watch the position.
I have opened a position in SPX (S&P 500) options expiring in the next 2 weeks. The opening position is a Calendar spread in which I sell an option (1980 strike Call) expiring in 1 week, Sep 25 – (officially 26th, but that is a Saturday, so the position will be closed before the close on the last day of trading – Friday 25th). The option sold is covered by the purchase of an option at the same strike price (1980 Call) expiring 5 days later (Sep 30). This is known as a Calendar or Horizontal spread and the profit/loss graph looks as follows:
Maximum profit on this trade would be ~$6,000 with SPX closing at 1980 on Sep 25 – actual profits will depend on changes in price and volatility over the next week. Maximum loss is what I paid for this position $4.50 x 100 x 5 contracts = $2,250.
However, I expect to make a number of adjustments to this position (maybe up to 4 or 5) before this position is closed – therefore definitely not an investment trade.
Although I am (personal belief) mildly bearish on the market at the present time , this position is currently mildly bullish (following yesterday’s drop and the possibility of a bounce) but will be adjusted to bearish with some evidence of further market weakness.
There is more risk in this trade than I generally like due to the fact that volatility is a little high right now with Implied Volatility on these options at ~17% – also I prefer 7 rather than 5 days between the option expiration dates – both of these factors mean that closer attention to the position will be required.
I will update this post as adjustments are made.
Update 1 – 3:20 pm Sept 18:
In order to take advantage of time decay over the weekend I have sold a diagonal spread for a credit of $0.80 x 100 per contract ($400 on 5 contracts). A diagonal spread is similar to the calendar spread used to open the position (i.e. the options bought and sold have different expiration dates) but the strike prices are different. In this case I sold the Sep4 1960 Calls expiring on Sept 25 and bought the Sept5 1970 Calls expring Sep 30 to cover. The new position is as shown below:
I now have a position with a maximum profit of ~$8,000 and maximum loss of ~$6.700. While the reward/risk is less than for the original trade I have widened the profit area between the break-even points to about 80 SPX points (~1920-2000) and increased my probability of profit. In addition, this maximum loss is concentrated to the upside and maximum loss to the downside is limited to ~$1,800.
Other important things to note are that the position is relatively insensitive to price movement with a slightly bearish delta of -12, and the position theta (time decay) is $326 per day. These data can be seen in the figure below:
Probably more adjustments next week 🙂
Update – Sep 21 Review:
No adjustments today – current position is looking good – slight bearish bias with high theta (time decay):
Update 2 – 10:20 am Sept 22:
I have just adjusted this position by adding another diagonal spread – I have sold the Sep4 1940 Call Options expiring on Friday and purchased Sep5 1950 Calls expiring on Sep 30 for a net debit of 0.75 x 100 x 5 Contracts = $375. The new net position now looks as follows:
This moves my downside break-even to ~1900 and still leaves me with a maximum profit of ~$7,000 with SPX closing between 1940 and 1960 on Friday. Maximum loss is ~$15,000 but this is now ~2 Standard Deviations to the upside at ~ 2060.
Update 3 – 3:00 pm Sept 22:
Since I shall be busy doing other things tomorrow and won’t be sitting in front of my computer to watch this position I want to add a little more downside protection. I have therefore added yet another diagonal spread to the position. I have sold the Sep4 1920 Calls expiring on Friday and purchased Sep5 1930 Calls expiring Sep 30. 5 contracts of this spread have cost me 0.50 x 100 x 5 = $250. The new total position is shown below:
The position is mildly bearish (delta ~-48) with huge theta (time decay) of $1,340 per day. Vega (volatility) is a little high and this could hurt a little should prices rise and volatility in the longer term Options get crushed. However, volatility on the shorter term options is higher and this will go to zero at expiration. Note that my break-even points are now outside the 1 Standard Deviation band (light blue area) giving me a better than 68% probability of a profitable trade.
Update – Sep 23 Review:
No adjustments today – so here’s what the P/L Risk Graph looks like at End-Of-Day today with 2 days to go before I exit the position:
Volatility has dropped so we see the impact of the volatility crush I mentioned above – maximum profits have dropped from ~$10,000 in yesterdays graph to ~$7,000 in today’s graph – same positions and little price movement but a “crush” in volatility premium. But still an ok looking position.
Update 4 – 12:45 pm Sept 24:
OK – I’m starting to wind this position down so I’ve sold the original 1980 Call Calendar Spread that I opened with last Friday. A small loss on this portion of the trade but with negative theta (time decay) this needs a big bounce to be worth keeping so I’ve sold it. Here’s what’s left (P/L includes the loss on the trade just sold):
Update – End-of-Day Sept 24:
Here’s how the position stands at the end of trading today:
Update: Position Closed
I have closed all legs of this position with a net profit of $6,000. The credits received for the closing trades can be seen in the figure below:
$6,000 profit on a one week trade is very nice – but please don’t get the impression that this is to be expected. My goal with these trades is an average weekly profit of $2,000 – which would still work out at $100k per year if the goal was achieved. Because I do not wish to spend so much time watching these trades I do not put them on every week – this was just an example to demonstrate one of the benefits of trading Options. It happened to work out very well, but this level of profit is not to be expected – $2k is a more realistic expectation.
A couple of points to keep in mind:
- Maximum loss on this trade was defined at ~$15,000 – but this was ~2 Standard Deviations from the price at which SPX was trading at that time and the probability of reaching that level would be ~7.5% even if adjustments were not made – and, of course such changes would be made – plus a maximum stop/emergency exit might be set at ~$5,000.
- Exiting (and entering) these positions is maybe not quite as easy as it may seem reading these posts. Spreads on SPX Options are quite wide so an estimate has to be made as to the “fair price” that should be paid/received. Patience is then required to get fills at acceptable limit prices – market orders will not generate good results. SPY may seem to have tighter spreads but the contract size to generate the same level of profit is ten times the number of SPX contracts required. On top of the 10x multiplier on the spread there is also the 10x multiplier on commissions – so, in the end, not much difference. Maybe a little less patience is required for SPY because of more liquidity – but I just don’t like looking at those big commission numbers.