Welcome back NavigationTraders!
In this tutorial, we're going to discuss trading a Calendar Spread. Right now implied volatility is extremely low in almost every underlying that we trade. Today is August 19, 2016.
Let's take a look at RUT, which is the Russell 2000 Index. If we take a look at the chart, you’ll see where the implied volatility is right now. We've got an IV rank of zero and an IV percentile of zero, meaning over the last year it's at the lowest point that it's been.
We can't really sell Iron Condors, Strangles, or any type of strategy that requires high implied volatility, because we won't collect enough premium to make it worthwhile. We want to look to other strategies, and in this case, we're going to trade a Calendar Spread.
We want our front month to have anywhere between 30-45 days to expiration, so the September option cycle with 37 days to expiration works for us.
We always want to enter our Calendar Spread as a delta neutral strategy, so we do it right at the money. RUT is currently trading at $1232. I like to default to the strike just below where price is trading.
We will start on the Put side.
I’ve selected the 1230 Put Calendar. All you have to do is right click, and then select “BUY”, and then click “Calendar”.
Down below it will populate your order; however, it always defaults to the next expiration cycle even if it's a weekly option. I like to stay in the monthlies because they're the most liquid, and they have the tightest bid ask spreads.
The next monthly is the October 21 options. So, let's go ahead and change the top box in our order entry area to the October 21 cycle.
Analyzing The Trade
Right click on the order and select “Analyze Trade”.
I’m setting our price slices to break-even. This expires on 9/16, so I’ve changed our calendar up at the top to 9/16.
You can see below what our Calendar Spread looks like. We're paying about $13.55 for the spread, which means our max loss is $1355 whether the market explodes or goes down.
Ideally, we want prices trading right at the money. Our initial probability of profit is 38%.
Calendar Spreads are fairly low probability trades. But, if implied volatility does increase, we’ll see these break evens expand out to a wider range, making for a higher probability of profit.
Our goal is to close the trade at about 25% of the debit paid. We're paying $13.55, so when we make 25% of that we'll go ahead and take the Calendar off.
To enter the trade, simply right click the order and select “confirm and send”. Click the send button once so the dialogue box pops up.
We got filled right off the bat at $13.55. Now we are in the trade!
I hope this was helpful, we’ll see you next time.
-The NavigationTrading Team