So.. I got myself into a nice options seminar here in México and decided to get back to trade options. First day after the seminar, I looked for a setup with the new insight I just learned and placed the following:

+10 SPY JUN 131C, -10 SPY APR 131C for $1.59

That’s a calendar. S&P 500 historical volatility was way below average, and since it’s being trading for along time to the upside, and many sources I read are getting either nervous or complacent about it, I believe there might be an increase in IV in the near future. I chose APR-JUN basically on the price.

Tis trade has become an extremely interesting one, and I have learn a lot from staying on top of it, and looking at ways to manage it.

Profit, loss & risk

I forgot to write down the projected profit and loss, but based on the graphs, the (theoretical) maximum profit that this spread could make when I placed its something like $1750.- and the maximum loss possible is the price I paid for the spread which is $1590.-

Now, since this is a calendar spread the maximum theoretical value is unknown, it will vary greatly over time, mainly moved by the variation in IV (implied volatility), which is the general idea. On the other hand, there is almost no way this spread will remain open till the day after April expiration; if the price sits above $131 close to April expiration (that is, the short leg is ITM) then I will get assigned on the short calls, meaning I need to sell SPY stock at $131, which I don’t have; I’ll need to buy it at any price available and lose that money. Fugly to say the least.

On the other hand, if the price ends below $131, then no assignment will occur and that leg will expire worthless, leaving me with the premium I received when I sold those calls ($3.15 x 10 x 100 = $3150) In any case, that’s just too much risk; the whole idea of a market-neutral trade is to avoid directional risk.

Entry & Exit

The entry is discussed above. The exit is more complicated.

Since the max profit is unknown, when I leave this trade is entirely a judgment call. Here are some ideas:

1. Take $500 and run. That’s like 28% of profit.
2. Roll the calendar to a less risky or maybe totally riskless trade. That will happen by selling 10 APR/MAY calendars. The April calls get closed, and I’m left with a MAY/JUN Calendar. ToS has another cool strategy. Buy the JUN/SEP calendar and roll it further! I’ll look into that.
3. Take $875 and run, that’s 50% of the trade
4. Close the whole thing no matter what, the week prior to APR expiration.

Trade Log:

04/feb/2011: Placed it last friday, feb 4th. Got filled at my price, which is a HUGE difference with my prior trades. The tip of the calendar PL graph sits right at the ATM strike, almost delta-neutral. If Sheldon was right, this is an almost pure volatility play, at least at this time

08/feb/2011: No increase in IV, price moved almost two full strikes to the upside. Trade losing $50

09/feb/2011: Slight increase in IV, price retreated also slightly. Trade losing $35

11/feb/2011: Hosni Mubarak decided to leave the egyptian presidency and the american investors decided that this was worth buying everything. Big move to the upside, SPY closed over $133, hurting my position. Trade losing $60.

23/feb/2011: After a few hectic days in world news, the market started to retreat slightly for the last two days. At this time (noonish, CDT), Libya might oust Moamar Ghadafi after a brief but bloody week or so. This news coincides with the pullback, go figure. IV has increased a lot (currently above 20% for this spread). Trade making $215 or so.

02/mar/2011: I’d like to think that the timing and rationale to place this trade was correct; so far this trade has worked out flawlessly. Trade making $355 . IV has either increased steadily or at least remained higher than when the trade was placed, gamma is hurting the position, but only by a small margin. On other news, Libya is sinking into a bloody civil war, oil has topped $100, Gold and Silver are skyrocketing.

04/mar/2011:  After basically looking at this trade and not doing a thing to manage it, I decided today to roll it.

A roll is made when you buy/sell part of your calendar and convert it to another. The original I placed was 131C APR/JUN SPY. Today I ended up with a 131C MAY/JUN SPY, here’s all about why and how I did it.

Rationale for rolling

I must confess that part of me wanted to do something with this trade, since it’s been a whole month just sucking time of my working day by looking at it. But in reality, that’s not the reason I rolled. The reason was :

• Reduce the risk of the trade
• Lock in the profits I set up in possible exit point 1

In FOREX or stock trading, you can place a stop-loss or moving-stop-loss type of order, but I learned that the way to achieve the same thing in calendars is by rolling them.

How to make a roll

I setup my analyze tab to show the current price of the needed roll, and did some math. The current price of the APR/MAY roll was $1.27 . For me, this meant that since I bought the APR/JUN @ $1.59 if I sold the roll, I could end up with $1.59 – $1.27 = $0.32 as my maximum risk. As risk reducing, this move can fit the bill. This part is incorrect. nop, is quite right.

But what if the 131C MAY/JUN SPY calendar is trading around $0.30 cents? That would mean that the second part of the rationale won’t be achieved, which is to lock in some of the profits. I looked at what the market is pricing it and it turns out that it costs $0.72. So, by executing this plan, I end up with a $0.72 trade for $0.32. Looks like a deal! If things look fishy coming monday, then I could just close the thing and cash in $400 (that is: sell it in $720 or so, and since my risk is $320 pocket the rest). This whole thing is also wrong. Also correct.

After the order went through, All of the above math checks out, but for some strange reason, my risk is only $100 and my current profit (at %19 IV) sits at a whooping $605. I don’t understand why, it seems that the options are overpriced or something, I’ll look into it next monday. also wrong!

What I should be looking at at this time, is not the _original_ price of the trade, but the _current_ price of the trade. The calendar was trading at this time at somewhere around $2.00.  After rolling the numbers are: $1.98 for the APR/JUN  - $1.27 for the APR/MAY = $0.71 for a MAY/JUN This is wrong

The market price for the MAY/JUN is $0.72, and I’m rolling for $0.71 which means I reduced my risk from $1.59 to $0.01. Good, but I should have waited a week or so (maybe more) until I could _truly_ lock in some profits. For example, at 08/march/2011 (at some point intraday), the numbers WOULD be: $2.12 for the APR/JUN – $1.33 for the APR/MAY = $0.79 When the current price is $0.75 thats $400 $40 of sure profit. Ok, this is wrong.

The exit point of $500 should be the target of the first roll. And maybe the ultimate profit for this strategy is $500 x the number of rolls; UNLESS the trade performs like a champ, then just let your profits run! look! wishful thinking!! this is incorrect.

This is a partial on the WOULD be part of THE ROLL (actual prices of the live trade are different, this is only a glimpse into how to time a roll)

Date	Price of the APR/JUN (1)	Price of the APR/MAY (2)	(1) – (2) for the MAY/JUN	Actual price for the MAY/JUN	P/L
04/march/2011	$1.98	$1.27	$0.71	$0.72	($0.01)
08/march/2011	$2.07	$1.31	$0.76	$0.75	$0.01
09/march/2011	$2.10	$1.34	$0.76	$0.76	$0.00
10/march/2011	$2.06	$1.29	$0.77	$0.76	$0.01
11/march/2011	$2.14	$1.37	$0.77	$0.76	$0.01
14/march/2011	$2.16	$1.36	$0.80	$0.76	$0.04
16/march/2011	$1.90	$1.21	$0.69	$0.68	$0.01
21/march/2011	$2.28	$1.45	$0.83	$0.82	$0.01
24/march/2011	$2.31	$1.45	$0.86	$0.85	$0.01

After following the price differences over time between the original trade and each of the closing prices for the roll trade, I can say that they are always the same, as the table above shows. This means that there will always be a $0.01 difference for the roll meaning that both calendars are fairly priced. So, the criteria for rolling is not to exploit a price difference between different calendars, it must me something else!

10/march/2011: Today there was a terrible selloff, I don’t have a clue why and I’m quite sure nobody does, either. It coincided with Libya sinking into a bloody civil war and maybe some other unavailable news that I’m not aware of. Trade doing quite well, up $660 in Analyze, $450 actual

At this point I’m wondering what to do with this trade. I’m making $660 / $1590 = 41% so far. The theoretical profit is unknown, but it depends on unrest and the price staying at $131 my the third saturday of May, IF those things happen (major unrest for more than 60 days and yet the price taking it’s place at 131 on cue) I could make over $2500. That’s 160% profit or so.

That does not look too possible now, and the market knows it. IF it was a sure thing, then there would be no volatility (which is a measure of uncertainty and fear). The zurich axioms point at taking your profits too soon. Is this too son? or it’s too late already?

I wasn’t thinking all this things when I put the trade on, and the only reason I can think of is that at the beginning, there was no real money involved. If this trade goes against me in a BIG way ($100-ish or $160-ish) then THE MOST I CAN LOSE IS $100$320 Should I take what little (or big) money I have now or just let it ride? I’m inclined to think that letting it ride is reckless; that’s just the way I am. I can’t remember a single time in my life that “letting it ride” gave anything good. I’m thinking to just close this thing, maybe salvage $500. BUT on the other hand, there’s NOTHING wrong with this trade, yet!, What if I’m trying to outsmart the market (betting on a direction)? maybe I’m getting spooked for a measly 2% drop?

11/mar/2011: Very sad news. The fourth biggest earthquake in the recorded history of mankind hit Japan today. The ensuing tsunami was horrifying to say the least. Trade still making the same $660 in Analyze, $450 actual as yesterday. I’m updating the roll table as well.

14/mar/2011: The news in Japan are only getting worse. Fears of complete nuclear meltdown is in the news constantly. Price took a dive today, breaking below the “price box” of the last 5 weeks (closed @ $129.58). That meant an increase in IV, which today closed at 21% for this calendar and it keeps making money! $680 in Analyze, $440 actual. Updating the roll table with current data.

I noticed that one of the criteria of the roll should be to keep a big vega, or else this turns into a time calendar. The original trade had well over 110 vega and this one sits at 40-something.  I traded an IV-sensitive trade for a slowly time-increasing trade with a BIG amplitude. This should just wipe all my fears! I changed a $1590 risk for $100 $320 risk in four weeks. That’s GREAT. If the world comes to an end, I’ll lose $100 $320. I can sit smugly and don’t give a CRAP about this trade. Or be reasonable and diligent and try to exit at a somewhat nice profit level. I think $500 is my rock bottom profit, Which would happen if this thing crosses $123 on the downside or $139 on the upside. Which very well could be tomorrow or today while I’m sleeping.

16/mar/2011: I entered a hedge trade. It’s documented here: [intlink id="1103" type="page"]SPY Bear Call Spread[/intlink]. That changed the whole position, but if we analyze this calendar by itself, it took a hit and it’s now making $575 in Analyze, $360 actual. The theo model predicts that I should be making $650ish, and that might be an arbitrage opportunity, but I’m not skilled enough to attempt anything about it. Just sayin’

21/mar/2011: I closed the hedge today, with a loss. But this trade still doing great. Up $715 in Analyze, $500 actual and looking really good. The market rallied overnight and moved inside my setup.

One thing to note is that I got an “IV crush” today, when this market traded in a very narrow (50 cent) range all day. That’s no volatility at all! at market close the ticker read 20% IV when I’m positive I saw a 25% or something huge like that a few days ago.

24/march/2011: News are quite the same, Japan’s reactors give us a scare one day and the other too. Libya’s military is being reduced to cinders by the NATO. IV Crush still going strong; today’s read is 18.2%! Anyway, this trade is still making money, up $745 in Analyze, $530 actual.

On thing of note is that maybe all the happy numbers I made when I made the roll, are actually true, I’m beginning to think that the TOS platform is being too conservative.  The “Monitor->Account statement” tab on the platform shows a mark value of $855 for the whole of SPY but “Monitor->Activity and Positions” show a P/L open of $745. The P/L graph does show a possible loss of $110. Could it be that making the roll confused the platform, and since the last move was a credit, it keeps showing the $110 as margin, hence deducting it form the mark value of this position?

Updated P/L Information

28/mar/2011. midday : At long last I figured out how to properly measure the PL of a rolling calendar. Here it goes.

($1.59) DEBIT for the original SPY APR/JUN 131C Calendar. on 4/feb/2011.
+$1.27 CREDIT for the roll trade of SPY APR/MAY 131C Calendar on 4/mar/2011
———
($0.32) Current PL. It can be offset only one more time by SELLING the SPY MAY/JUN 131C Calendar. The table below shows the current price for that trade in column (E).

At this point there are possible outcomes have I decided to roll or not. Here’s a quick summary.

Date		(A)	(B)	(C)	(D)	(E)	(F)	(G)
------------	-----	----	----	-----	----	---	----
04/march/2011	1.98	1.27	0.39	-0.32	0.72	0.4	0.4
08/march/2011	2.07	1.31	0.48	-0.28	0.75	0.47	0.43
09/march/2011	2.1	1.34	0.51	-0.25	0.76	0.51	0.44
10/march/2011	2.06	1.29	0.47	-0.3	0.77	0.47	0.45
11/march/2011	2.14	1.37	0.55	-0.22	0.77	0.55	0.45
14/march/2011	2.16	1.36	0.57	-0.23	0.76	0.53	0.44
16/march/2011	1.9	1.21	0.31	-0.38	0.68	0.3	0.36
21/march/2011	2.28	1.45	0.69	-0.14	0.82	0.68	0.5
24/march/2011	2.31	1.45	0.72	-0.14	0.85	0.71	0.53
28/march/2011	2.36	1.49	0.77	-0.1	0.86	0.76	0.54
30/march/2011	2.34	1.49	0.75	-0.1	0.85	0.75	0.53
31/march/2011	2.4	1.53	0.81	-0.06	0.87	0.81	0.55
04/april/2011	2.33	1.43	0.74	-0.16	0.89	0.73	0.57
16/april/2011	2.71	1.72	1.12	-0.13	0.98	0.85	0.66

(A) is the price of the original trade. (B) is the apr/may roll. (C) = (A)-$1.59 is the PL if I just decided to close outright on that particular date, (D)=(B)-$1.59 is the difference between original and roll, wich results in a MAY/JUN calendar but at a different price than (E) which is the ticker price of the MAY/JUN calendar.

(F)= (E)-(D) shows the possible PL have I decided to exit the new, rolled position (that is, buying @market the MAY/JUN calendar). (G)= (E)-$0.32 shows the real PL for my whole position.

I believe the decision to roll, albeit a good one, was a bit premature. The same roll, if executed on the 24, could have reduced the risk half of what I got and leave me with $710 profit instead of $400 then and $530 today. And that’s only 20 days later!

I need to come up with precise exit points. Some percentage over the original risk minus the credit of the roll plus commissions. The RoR (yield or rate of return) would be (Vf – Vi) / Vi (http://en.wikipedia.org/wiki/Rate_of_return) . Taking into account the credit I received by rolling, then I should be looking at a price to close the position. That’s the column(E) or the mark price of the SPY MAY/JUN 131C calendar

• 30%: 1.59 x 1.3 =2.067  - 1.27 + 0.09 @0.88
• 50%: 1.59 x 1.5 = 2.38  - 1.27+ 0.09 @1.2
• 60%: 1.59 x 1.6= 2.54 – 1.27+ 0.09 @1.36
• 80%: 1.59  x 1.8 = 2.86 – 1.27+ 0.09 @1.68

30/mar/2011: This markets is inching higher. I think I’ll end up closing below my 30% profit target. Trade is doing ok, up $740 in Analyze, $530 actual

If you think about it, the exit price points should take into account that the first roll was also a “milestone”. It allowed me to move from -100% risk to -20% risk.

31/mar/2011: No idea what the news are today. Trade up $760 in Analyze, $550 actual

04/apr/2011: Again, nothing newsworthy. Trade up $785 in Analyze, $570 actual

16/apr/2011: This is the saturday after expiration for the APR options. SPY decided to close yesterday @$132.05, and giving me some time to reflect.

After rolling, I reduced my risk to a pittance. BUT didn’t make me any money. Had I shown balls of steel and stayed up to last Wednesday, I’d clear $1305 profit. As it stands now, I have a P/L of $875 in Analyze, $660 actual. This is a backtrade analysis of the original trade:

And here is an awesome view of everything I’ve written so far:

The yellow wiggly line is the price of the total P/L of the positions selected.

20/april/2011: Right before market open, I come to find my trade completely destroyed, not by price action, but by vol crush. I thought I’ve seen it before, but this is remarkable:

This was taken right before the bell, It might have closed like this yesterday, but I didn’t check. After the bell, things jumped to normal. Platform glitch maybe?

04/may/2011: 14 days have passed since my last update. LOTS of things have happened, but let me explain graphically:

Right after the ominous doji on the 18/apr, this market just shot upwards without stopping for breath. Right trough 2/may where it started a moderate retrace  (that I think should last for a couple of days, not more.) The price of my calendar spread fell like a rock.

This caused me to shut down. I stopped following the price action on my mobile and the panic drove this position totally away from my attention. THIS IS WRONG!!! even though I could say that the ultimate risk is minimal, I should be paying the same attention I did when the trade was performing like a champ. Trade making $655 on backtrade, $868 on analyze.

Oh! and Osama Bin Laden was shot dead on Sunday in his hideout in Pakistan by a team of Navy Seals. Then his body was committed to sea.

This is the Analyze PL graph so far:

And the Price action charts:

6/may/2011: I closed the position today. Here is the historical backtrade tab (I wish I learned it before, it would have saved me 50% of this post)

And the price action charts:

I closed it @1.00 even. I bailed out at roughly the 30-40% max price as shown in the analyze tab. The reasons where:

1. I was not comfortable with the trade. The upper trendline extending since last month did not get broken today, so I’m inclined to think that it might continue moving forward, eroding my profits.
2. The trade seemed broken, the 131 level for this market was passed over and under all the time, and there is no guarantee that it would get better for me in the future.
3. I’m personally busy next week, and it would add to my lack of comfort knowing that I have to babysit this trade for another couple of weeks.
4. The Zurich axioms say to take your profits early. This is 14 days early, and this is a winning trade already, so I took my profits and left the table.

So here is the simplistic, real P/L:

DATE	TIME	DESCRIPTION	COMMISSIONS	AMOUNT
4/02/11	14:01:05	BOT +10 CALENDAR SPY 100 JUN 11/APR 11 131 CALL @1.59 ISE	-$30.00	-$1,590.00
4/03/11	13:55:33	SOLD -9 CALENDAR SPY 100 MAY 11/APR 11 131 CALL @1.27 ISE	-$27.00	$1,143.00
4/03/11	13:55:33	SOLD -1 CALENDAR SPY 100 MAY 11/APR 11 131 CALL @1.27 ISE	-$3.00	$127.00
6/05/11	14:51:52	SOLD -9 CALENDAR SPY 100 JUN 11/MAY 11 131 CALL @1.00 ISE	-$27.00	$900.00
6/05/11	14:52:00	SOLD -1 CALENDAR SPY 100 JUN 11/MAY 11 131 CALL @1.00 ISE	-$3.00	$100.00
		Totals	-$90.00	$680.00
		RoR w/o comissions		42.77%
		RoR w/ comissions		37.11%

Let’s hope other trades do as good as this one. It was fun!.

Update, @MAY expiration

I wanted to see what exactly happens with the prices at expiration: Here is the backtrade graph.

The interesting bit of information is what happens to the spread price with both volatility and time to expiration.

I commented in the graph all of the major price fluctuations (low to high, and viceversa), and their corresponding impact in the spread (closing price):

    14/march - 16/march 	-4%	-2.29%
    16/march - 25/march 	 5.24%	 1.24%
    21/march - 6/april  	 3.83%	 1.31%
    6/april - 18/april 		 3.41%	 0.89%
    18/april - 2/may 		 6.08%	-3.73%
    2/may - 5/may 		-3.08%	 3.6%
    5/may - 10/may 		 2.35%	-2.95%
    10/may - 17/may 		-2.97%	 6.22%
    17/may - 19/may 		 2.27%	-3.19%
    19/may - 20/may 		-1.22%	 3.72%

The closer we get to expiration, volatility has a greater impact in the option price. That means that relatively big swings early on in the trade should not worry me; it’s worth noting that this trade was profitable most of the time – 3 of the four months this trade was on– and maybe that’s a sign of a good trade. I assume that every trade should be different, so this should be more of a guide than a rule for me.

The other thing that I need to have clear is early assignment. I sold the MAY 131C and bought the JUN 131C. That means that I risked assignment on the MAY calls anytime this market traded above $131 –which happened strongly on the 29/april.– I didn’t get assigned maybe by blind luck or maybe because that was still far away from the 20th of may.

I didn’t have any risk of assignment of the JUN calls, since a) they’re very far away from expiration and b) I bought them so I don’t have any obligation on them.

All this means that if the price is inside the “tent” on the downside, then I can go all the way (or at least closer) to expiration –given that the trade seems profitable by then, of course– and try to catch as much volatility as possible, since there’s no way I’ll get assigned. If the price is inside the tent but on the upside, then the closing was well timed. Two weeks before expiration should protect me most of the time. Anyway, when I get assigned –not if– I’ll exercise my back month options and maybe even continue on the trade.

Lastly, here’s how each of the calls changed it’s value over time:

The short MAY 131C:

And the long JUN 131C:

(btw don’t pay attention to each option buying price, since they came from a previous roll)