Futures options spread lesson #3, the Calendar Spread.
This is another option spread I utilize quite often.
The Calendar Spread is a credit spread. A credit spread simply means you are collecting a net premium when placing this type of futures option spread. With a Calendar Spread, we are simply selling an ‘out-of-the-money’ futures option in one month and then buying that same strike price in a nearer month.
The example I’m using is the Coffee futures market. As you can see in the charts below, Coffee had been trending downwards for several months. For this trade example, I’ll be using July ’15 and September ’15 charts. Looking at the chart formation, I felt Coffee would not shoot up over 68 points based upon my technical and fundamental analysis. With this in mind, I’d sell the 210.00 Calls in the September contract and buy the 210.00 Calls in the July contract. I’ll collect 180 points ($675) for the September Calls and I’ll pay 85 points ($318.75) for the July Calls leaving me with a credit of 95 points ($356.25), which will be the maximum gross profit on this trade (one point in Coffee futures equals $3.75). Remember to account for trade commissions and fees when calculating your profits and losses.
In using a futures option Calendar Spread, we are gaining the following benefits as opposed to just selling an option outright (not in a spread)…
- Longer staying power. If Coffee futures were to have a large jump in price, my long July Calls would be rising in value to help offset some of the losses on the short September Calls giving me time to re-evaluate the trade.
- Lower margin requirements. By trading a spread, we can benefit by lower margin requirements as opposed to selling an option outright. In this example, the margin difference is almost 30% lower for the futures option spread.
- Better for volatile markets. A market like Coffee futures can be volatile, up big one day and down big the next. By utilizing a spread, we are attempting to calm the volatility by being both long and short, again, giving us longer staying power to ride out the volatility.
Of course, we do have some downsides to the Calendar Spread. Because this is a spread, we typically have to hold the trade longer to realize a profit. We also will have higher trade commissions and fees as we are trading multiple contract months as opposed to just trading one month.
Another point to keep in mind that can be a negative aspect is that the futures option purchased, in this case, the July 210.00 Calls, will expire 2 months prior to the September futures option sold leaving you ‘naked’ the short side. My personal feeling on this is that once I’m that far into the trade, I have a pretty good feeling if it’s going my way or not so by the time the purchased option expires, I’ll know if I’m going to hold on or get out.
As always, no futures option strategy is guaranteed to produce profits. This strategy can result in a loss. It’s important to determine both the profit and loss you are willing to accept for every trade you enter, before you enter the trade.
I hope you’ve found this futures option information valuable. I know options trading can get a little confusing, especially when we start introducing spreads. If you have any questions about this strategy, please feel free to contact me.
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