35 lines
2.4 KiB
Plaintext
35 lines
2.4 KiB
Plaintext
December call go to zero, the position is still a profitable trade because of
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the continued month-to-month rolling. This is now a no-lose situation.
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When the long call of the spread has been paid for by rolling, there are
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three choices moving forward: sell it, hold it, or continue writing calls
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against it. If the trader’s opinion calls for the stock to decline, it’s logical to
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sell the December call and take the residual value as profit. In this case,
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over three months the trade will have produced 4.50 in premium from the
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sale of three consecutive one-month calls, which is more than the initial
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purchase price of the December call. At September expiration, the premium
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that will be received for selling the December call is all profit, plus 0.50,
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which is the aggregate premium minus the initial cost of the December call.
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If the outlook is for the underlying to rise, it makes sense to hold the call.
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Any appreciation in the value of the call resulting from delta gains as the
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underlying moves higher is good—$0.50 plus whatever the call can be sold
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for.
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If the forecast is for XYZ to remain neutral, it’s logical to continue selling
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the one-month call. Because the December call has been financed by the
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aggregate short call premiums already, additional premiums earned by
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writing calls are profit with “free” protection. As long as the short is closed
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at its expiration, the risk of loss is eliminated.
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This is the general nature of rolling calls in a calendar spread. It’s a
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beautiful plan when it works! The problem is that it is incredibly unlikely
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that the stock will stay right at $60 per share for five months. It’s almost
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inevitable that it will move at some point. It’s like a game of Russian
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roulette. At some point it’s going to be a losing proposition—you just don’t
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know when. The benefit of rolling is that if the trade works out for a few
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months in a row, the long call is paid for and the risk of loss is covered by
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aggregate profits.
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If we step outside this best-case theoretical world and consider what is
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really happening on a day-to-day basis, we can gain insight on how to
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manage this type of trade when things go wrong. Effectively, a long
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calendar is a typical gamma/theta trade. Negative gamma hurts. Positive
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theta helps.
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If we knew which way the stock was going, we would simply buy or sell
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stock to adjust to get long or short deltas. But, unfortunately, we don’t. Our |