My investment strategy for trading calendar options is to collect premiums from selling calendar spreads on far out-of-the-money (OTM) options that are statistically unlikely to expire in-the-money (ITM).
My criteria for selection are as follows:
- Spreads must be made as the premium receiver or spread seller
- Calendar options must expire in sequential months
- Strike price must be set at or outside of the 2.5σ / 98.8% confidence interval
- Max potential return on margin must be greater than 4%
Additionally, by trading in options at strike prices that are at least 2.5σ away from their recently traded prices, this strategy also attempts to exploit the long-observed volatility smile pattern. After the 1987 stock market crash, OTM options traded at higher implied volatility than ITM options, which makes them relatively more expensive. Since I am a seller not a buyer of these options, I will profit more over time from selling far OTM vs. ITM options.
As shown in the charts below, strike prices for Union Pacific (UNP), Whole Foods Market (WFM), Hess (HES), Anadarko Petroleum (APC) and Abercrombie & Fitch (ANF) all fall at or outside of the 2.5σ / 98.8% confidence interval. The gray lines are Bollinger Bands, which are based on a trailing 60 trading days and a 2.5σ range.
Option Strategy Details:
Union Pacific Corp
- Spread: Short calendar put spread at $75 strike price
- Effective Exposure: Long UNP
- Months: Long Jan and short Feb
- Premium Received (at midquote; exclusive of trading costs): $0.39 per option ($39 for entire contract)
- Margin Required: $797.40
- Max Potential Return: 4.89%
Whole Foods Market
- Spread: Short calendar call spread at $80 strike price
- Effective Exposure: Short WFM
- Months: Long Jan and short Feb
- Premium Received (at midquote; exclusive of trading costs): $0.43 per option ($43 for entire contract)
