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The April/ May calendar put spread on the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) has a good expected return with limited risk. When a calendar put spread is purchased, the maximum potential loss is the amount of the spread or debit paid to open the position. This is a limited risk trade, with good upside potential and positive expected return.

The current price of the SPY is $137.14. For this trade, we are going to sell the April 21st $137 put for $1.30 and buy the May 19th $137 put for $3.04. The net debit is $1.74. If you're going to set your maximum risk at $1000, which would be 1% of a hypothetical $100,000 trading account, you'd use five contracts.

With five contracts, the maximum possible loss would be $880. The maximum gain on this trade is $363.96 and the expected profit is $270.35. This is assuming that the position is closed by the April 21st option expiration. The position will be essentially delta neutral at the onset of the trade, the delta of the April 21st $137 put is -48 and the delta of the May 19th $137 put is -48.

Profit can be taken anytime the spread widens, but most traders will wait until April the 13th at the expiration date of the short puts - that's when the IV or implied volatility of the short put will collapse into expiration and that's where traders should look to take profits. If you have more than one contract when the trade is initiated, you can always consider taking partial profits along the way if the spread widens.

Some traders will allow the stock to get put to them at the short strike price and then hold the married put position until the far expiration with the same limited risk. If the SPY is below $137 on April 21, you could let the stock get assigned to you, hold for a week with your long puts protecting the position, and your risk is still limited to the original $880. Your breakeven now will be at an SPY price of $138.74.

There are several ways to manage the risks in this trade. One is to make delta adjustments to keep the trade delta neutral as time goes on. This can be done by buying back some short puts if the SPY declines or adding calls if it increases. If you sell the long puts without covering the shorts, it is no longer a limited risk trade.

Another strategy if SPY is below $137 at the first expiration is to let the shares get assigned to you, then as an alternative to waiting for SPY to exceed your breakeven of $138.74, you can look to try to sell the May 137 calls for more than your initial net debit of $1.74 and create what is known as a conversion. If you can sell the $137 call at anytime for more that your initial debit you are locking in your profits.

For those not familiar with expected profit, it is calculated by summing the multiples of the probabilities of the stock being at each price by the result of the position at that price. When trading options, it is critical to evaluate your position in terms of expected return or expected profit and only take trades where the probabilities are in your favor. Use an option calculator for each trade to compute the expected return. This trade on SPY has a very good probability of success with a defined risk. Correct position sizing is also important. In general terms, you shouldn't risk more than 1% of your portfolio on any given trade.

The profit and loss graph for this shows where the breakeven points are in visual terms.

Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: SPY Calendar Put Spread