The Beauty Of The 'Neutral Calendar Spread' Using Weekly Options

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Includes: AAPL, BA, BIDU, C, CF, CRM, CSCO, GLD, GOOG, IBM, INTC, JNJ, MCPIQ, MMM, MSFT, NFLX, QQQ, VXX, WMT
by: Kevin M. O'Brien

While I am a big proponent of many options strategies, and I try to know them all, one of my favorite trades to make is the neutral calendar spread using weekly options.

Generally, I do not like to trade weekly options when I am bullish or bearish on a stock. However, they have opened up many doors that have been previously unavailable. For example, I use weekly 'reverse iron condor' strategy with the SPDR Gold Trust (NYSEARCA:GLD), Molycorp (MCP), Citigroup (NYSE:C), and the iPath S&P 500 Short-Term Futures (NYSEARCA:VXX). For more information on those trades, please see these links here and here that I wrote on Seeking Alpha.

The "neutral calendar spread" is a strategy that should immediately peak your interest using weekly options. If you are looking for a higher return on investment using any other debit or credit spreads, you will not find one. There are several important factors, however, when choosing to place this trade, which I will go into extensively.

In this article, I would like to explain to you how I prefer to use this strategy. Some may disagree with my method, but I will never complain about the results. This trade is extremely manageable and offers many "options" before expiration.

I hope you will be able to understand this strategy and add it to your arsenal of options trades that will consistently provide weekly income for you if the following guidelines are followed:

  • Try to use stocks that are heavily traded and non-volatile. Examples include Wal-Mart (NYSE:WMT), Cisco (NASDAQ:CSCO), Intel (NASDAQ:INTC), PowerShares QQQ Trust (NASDAQ:QQQ), Boeing (NYSE:BA), 3M (NYSE:MMM), Johnson & Johnson (NYSE:JNJ), Microsoft (NASDAQ:MSFT), and International Business Machines (IBM).
  • The stock must have weekly options available or when it is the third Friday of each month, which is options expiration. For a list of available weekly options, please see this link here.
  • Place this trade on Tuesday afternoon (preferably only an hour or two before the market closes) for the weekly option.
  • Avoid volatile stocks, such as Salesforce.com (NYSE:CRM), Apple (NASDAQ:AAPL) -- especially right now, CF Industries (NYSE:CF), Baidu (NASDAQ:BIDU), Netflix (NASDAQ:NFLX), etc..
  • The strike prices are aligned neutrally according to what the stock is currently trading at when the trade is placed. This is extremely important. Quite simply, some trades just makes no sense. If one side (the call or put option) is biased towards one direction, it is not a good trade. There are too many other options available with the weekly options that it is time to move on and look for the better trade. This can often happen with stocks that have options available that trade in $2.50 increments. So be careful here.
  • Understand that the neutral calendar spread profits most when it is held just before expiration (Friday). This is when I will usually close the position, preferably 2:00 p.m. EST or 3:00 p.m. EST to gain the most. If the stock is trading where it needs to be according to your profit/loss chart, it will jump quickly in this time frame, literally by the hour.

To accurately place the neutral calendar spread according to my strategy, you would do the following:

Neutral Calendar Spread Construction

  • Sell 1 Near-Term ATM Call (weekly option)
  • Buy 1 Long-Term ATM Call (next month forward)

It should be noted that this can vary. For example, we will assume that a Wal-Mart trade using a neutral calendar spread looks promising. As a hypothetical example, the date is April 2, 2012. Since there are weekly options and the expiration of the monthly strikes is about two weeks away, I could use the weekly and the April 2012 expiration. I do not need to use the May 2012 expiration, only the April 2012 strike price.

On the same hand, if the Date is April 17, 2012, I would be forced to use the April weekly option and the May 2012 option.

I would also like to point out that there is a difference between volatility and true-range. To explain this, I want to mention a trade I made a couple of weeks ago:

On February 28, 2012, I decided to buy a Google (NASDAQ:GOOG) neutral calendar spread using the weekly option as the sell-to-open order and the March 2012 as the buy-to-open order. At the time of purchase, Google was trading near $619.00/share.

Date Open High Low Close Volume
Mar 2, 2012 622.00 624.00 620.32 621.25 1,573,214
Mar 1, 2012 622.26 625.70 618.15 622.40 2,238,010
Feb 29, 2012 618.60 625.60 615.50 618.25 3,136,837
Feb 28, 2012 610.00 619.77 607.68 618.39 2,847,797
Click to enlarge

Since I knew that March 2012 weekly (sell to open) strike price barely had two days left until expiration, I felt this was a high percentage trade. At the time, looking at my profit/loss chart on my trade calculator, I saw that Google would have to move up or down over $20.00/share for me NOT to profit. This appealed to me.

I have always viewed expiration Friday as a day where many stocks, especially those that are heavily traded, find themselves in a tight range. You can call it pinning, or whatever, but it happens all too frequently for someone not to notice this trend. Since I was placing this trade at an optimal time (Google was right near $620.00/share), I saw this as an extremely high percentage trade to profit. As it turned out, it was an excellent trade. The profit was tremendous for the initial upfront investment. This is a great example of finding a trade that made sense.

What I like to do every Tuesday is to spend an hour or two going through the list of weekly options available. From there, I will go to my trade calculator and punch in different strike prices on each stock that I feel will work great for the week. Often, many just do not match up. This is fine. The important thing is to be consistent in finding the trades that do make sense. Can it be tedious at times? Sure. Yet, I guarantee you that if you follow through with this practice every Tuesday of checking stocks or ETF with weekly options (or the third Friday of the month), you will stumble upon a great trade. It happens every single week.

For the most part, I try to limit my neutral calendar spreads to about three or four per week. If there is a particular one that really grabs my attention as a great trade, then I will be more aggressive.

One aspect about the neutral calendar spread that is extremely enticing is the ability to turn the trade into a bullish position immediately. Since you are long on a call(s)option, with the forward month, if you see the trade on the weekly moving up too much for your liking, you can simply "buy to close" the weekly option. Because you have a lot of time value left with at-the-money strike call options, this type of situation can actually make more than originally planned. This is a major benefit of this strategy: the ability to adjust. Sure, we would prefer to see time-decay benefit us on the sell to open weekly position.

Example Trade #1: Wal-Mart

  • Sell 25 MSFT March Week 4 $33.00 call options
  • Buy 25 MSFT April 2012 $33.00 call options

Requirements

Cost/Proceeds $1,275.00
Option Requirement $0.00
Total Requirements $1,275.00
Estimated Commission $62.50
Click to enlarge

Current Price: $32.85

Price Profit / Loss ROI %
24.64 ($1,275.00) -100.00%
27.83 ($1,275.00) -100.00%
31.18 ($890.00) -69.80%
32.45 $0.00 0.00%
33.00 $592.50 46.47%
33.60 $0.00 0.00%
34.54 ($655.00) -51.37%
37.89 ($1,202.50) -94.31%
41.25 ($1,212.50) -95.10%
Click to enlarge

Example Trade #2: Johnson & Johnson

Requirements

Cost/Proceeds $1,400.00
Option Requirement $0.00
Total Requirements $1,400.00
Estimated Commission $62.50
Click to enlarge
  • Sell 25 JNJ March Week 4 $65.00 call options
  • Buy 25 JNJ April 2012 $65.00 call options

Current Price: $65.07

Price Profit / Loss ROI %
48.75 ($1,400.00) -100.00%
55.00 ($1,400.00) -100.00%
61.59 ($1,290.00) -92.14%
64.30 $0.00 0.00%
65.00 $747.50 53.39%
65.75 $0.00 0.00%
68.17 ($1,115.00) -79.64%
74.75 ($1,275.00) -91.07%
81.34 ($1,277.50) -91.25%
Click to enlarge

Trade Example #3: Apple

  • Sell 2 AAPL March Week 4 $585.00 call options
  • Buy 2 AAPL April 2012 $585.00 call options

Requirements

Cost/Proceeds $2,880.00
Option Requirement $0.00
Total Requirements $2,880.00
Estimated Commission $12.95
Click to enlarge

Current Price: $585.56

Price Profit / Loss ROI %
438.75 ($2,875.80) -99.85%
495.02 ($2,675.20) -92.89%
554.25 ($755.80) -26.24%
564.95 $0.00 0.00%
585.00 $1,742.60 60.51%
607.37 $0.00 0.00%
613.49 ($416.80) -14.47%
672.72 ($2,366.00) -82.15%
731.95 ($2,749.60) -95.47%
Click to enlarge

Trade Example #4: Powershares QQQ Trust

  • Sell 20 QQQ March Week 4 $67.00 call options
  • Buy 20 QQQ April 2012 $67.00 call options

Requirements

Cost/Proceeds $1,460.00
Option Requirement $0.00
Total Requirements $1,460.00
Estimated Commission $50.00
Click to enlarge

Current Price: $66.68

Price Profit / Loss ROI %
50.01 ($1,460.00) -100.00%
56.49 ($1,460.00) -100.00%
63.30 ($1,150.00) -78.77%
65.84 $0.00 0.00%
67.00 $992.00 67.95%
68.26 $0.00 0.00%
70.12 ($856.00) -58.63%
76.93 ($1,356.00) -92.88%
83.75 ($1,358.00) -93.01%
Click to enlarge

Trade Example #5: Cisco

  • Sell 50 CSCO March Week 4 $20.00 call options
  • Buy 50 CSCO April 2012 $20.00 call options

Requirements

Cost/Proceeds $1,150.00
Option Requirement $0.00
Total Requirements $1,150.00
Estimated Commission $125.00
Click to enlarge

Current Price: $19.91

Price Profit / Loss ROI %
14.93 ($1,150.00) -100.00%
16.86 ($1,150.00) -100.00%
18.90 ($700.00) -60.87%
19.49 $0.00 0.00%
20.00 $1,085.00 94.35%
20.58 $0.00 0.00%
20.93 ($425.00) -36.96%
22.97 ($1,060.00) -92.17%
25.00 ($1,075.00) -93.48%
Click to enlarge

This will be the first part in a series of articles I will be writing on the neutral calendar spread strategy. If you have any questions, please leave a comment or e-mail me. I usually try to respond as soon as possible. Thanks again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I will enter these trades on a weekly basis on Tuesday's