The Calendar King by John A. Sarkett
A calendar spread is among the simplest of option strategies, yet among the most durable and profitable. A simplified explanation: the strategist sells a near-month contract and buys a far month against it. The near month loses value faster than the back month, and that is how a profit is generated.
As in most things, there is more to it than that, and that is why two years into the practice of trading calendar spreads, trader Himanshu Raval sought out an option mentor to learn the greeks. He found Dan Sheridan on a CBOE website video. Sheridan traded as an IBM market maker in his 24-year CBOE career, including thousands of calendars, so he knew whereof he taught.
Raval signed on as a student, and as a result, he doubled his returns from the 5% to 10% per month range to a 15% to 20% per month level, becoming something of a star in the option mentoring community.
He holds forth on the merits of a consistent approach. A meticulous recordkeeper, in the past year he has earned 18% per month on his IBM calendars with an average of 25 to 27 days in a trade.
Historically, IBM has moved less than 8% per month on average. The less the underlying moves, the better for the calendar spreader. Raval also tried other tickers — JNJ, PG, and DIA — but like many professional traders before him, he settled on Big Blue, IBM. Here’s how he does it.
Raval seeks to initiate a calendar position 40 to 45 days before the expiration of the short options. When volatilities are expected to either remain low or trend slowly higher, he takes bigger positions, both in size and number of strikes. A low volatility setting may find him starting with a triple calendar, with one calendar at-the-money (ATM), and then bracket that with calendars five or 10 points above and below. For example, if IBM is at 180, he may put on calendars at 180, 185, and 175.
If volatilities are high and expected to decline, the enemy of the calendar since the back month loses more than the front, and the position becomes flat or a loser, he may start with only one calendar ATM, and after that add calendars as the market moves.
Raval aims to pay the midprice (exact middle between bid and ask for the spread) but will at times pay up to 0.20 higher.