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An Interesting Calendar Spread Play:
As you probably know, I love calendar spreads. These spreads involve buying a longer-out option and selling a shorter-length option at the same strike price. You only have to come up with the difference between the two option prices when you place the order.
When the short options expire, if the stock is very close to the strike price of your spread, you can expect to sell the spread for a great deal more than you paid for it.The further away from the strike price the stock is when the short options expire, the less valuable the original spread will be.
The trick is guessing where the stock might end up when the short options expire. This takes a little luck since no one really knows what any stock is likely to do in the short run. But if it’s a stock you have followed closely, you might have an idea of where it is headed.
I happen to like GMCR. I like knowing that insiders have bought millions of dollars worth of stock in the past few months and 30% of the stock has been sold short (a short squeeze could push the stock way up). So I am guessing that the stock will be closer to $85 in six weeks compared to $80 where it closed yesterday (as I write this Wednesday morning it has moved up to about $81.50).
I bought a calendar spread on GMCR at the 85 strike, buying Apr-14 calls and selling Mar-14 calls. I paid $.85 ($85) per spread for 10 spreads, shelling out $850 plus $25 in commissions. Here is the risk profile graph for March 22 when the short options expire.
The graph shows that the stock can fall by as much as $5 and I will make a gain, or it can go up by more than $10 and I should expect a gain. This seems to be a pretty large break-even range to me. If I am lucky enough to see the stock end up near my $85 target, it is possible to triple my money in six weeks.
One nice thing about calendar spreads is that you can’t lose all of your investment. No matter where the stock goes, the value of the April options will always be greater than the price of the March options at the same strike price. When you are only risking $85 per spread, you can be quite wrong about where the stock ends up and still expect to make a gain.
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Terry
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