Time Was on My Side with Amazon

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way…

Charles Dickens, A Tale of Two Cities

The recent neck snapping volatility in the market has reminded me of this classic quote from Dickens. Many traders would certainly agree, and their trading accounts would attest, that we have glimpsed the worst of times. However for derivatives traders using option strategies,  the opportunities have never been better.

The factors which combine to define the world of the modern derivatives trader include:  inexpensive and robust analytic software, deeply discounted commissions, easy to use trading platforms, tremendously liquid option chains in many diverse underlying assets, the availability of rapidly decaying weekly options, and blazingly fast communication capabilities. As a result of these factors, trading opportunities present themselves almost continuously.

One of the problems that this plethora of opportunities creates is the fog of data overload. It is stunningly easy to lose focus and end up watching potentially profitable trades pass by.

I find it easiest to focus on the issues for which weekly options are available. The options exchanges routinely review the list of available weekly options and the list therefore represents the most liquid and active issues on the various option exchanges. An Excel spreadsheet containing updated listed weekly options can be downloaded from this CBOE site: http://www.cboe.com/micro/weeklys/introduction.aspx.

One of the new opportunities presented by the arrival of these recently available weekly options is the ability to trade what I call “hit and run” calendar spreads. Remember that a calendar spread is a two legged spread constructed by selling a shorter dated option and buying a longer dated option. The profit engine is the relatively faster decay of time premium in the shorter dated option.

Calendar spreads reliably achieve their maximum profitability at the expiration Friday afternoon of the short leg when price of the underlying is at the strike price. Prior to the recent availability of these weekly options, calendar spreads were typically constructed with around 30 days to expiration in the short leg.

Because price action remained strong and the upper breakeven point was threatened, I chose to add an additional calendar spread to form a double calendar. This action required commitment of additional capital and resulted in raising the upper BE point from 218 to a little over 220 as shown below. Hit and run calendars must be aggressively managed; there is no time to recover from unexpected price movement.

Shortly after adding the additional calendar spread, AMZN retraced some of its recent run up and neither BE point of the calendar was threatened. I closed the trade late Friday afternoon. The indication to exit the trade was the erosion of the time premium of the options I was short to minimal levels.

In these classically constructed calendars, risks are two:

1. Movement of price of the underlying beyond the limits of   profitability

2. Volatility crush of the longer dated option which the trader owns.

Hit and run calendars differ in risk somewhat. Volatility moves rarely occur at anywhere close to the rapid pace of price movement. Because of this characteristic, the primary risk in these short duration calendars is price of the underlying. The occasional occurrence of spiked volatility in the short option significantly increases the probability of profitability as the elevated volatility decays to zero at expiration.

One of the very liquid underlyings that has actively traded options is AMZN. At mid day August 29, AMZN was at $205.50 and continuing to trend higher from a basing pattern. A quick look at the options board showed the weekly 210 strike option, having 4 days of life left and consisting entirely of time (extrinsic) premium, was trading at a volatility of 42.9% while the September monthly option I would buy had a volatility of 41.6%.

This situation is called a positive volatility skew and increases the probability of a successful trade.  I entered the trade and owned the resulting P&L graph:

I continued to monitor the price, knowing that movement beyond the bounds of my range of profitability would necessitate action. By mid day on August 31, 48 hours into the trade, the upper limit of profitability was being approached as shown below:

The results of the trade were a return of 67.5% on maximum allowable managed capital risk and a return of 10.6% on committed capital. If the second calendar had not been needed to control risk, the returns would have been substantially higher.

This is just one example of the use of options in a structured position to control capital risk and return significant profit with minimal position management. Such opportunities routinely exist for the knowledgeable options trader.

In closing, I wanted to take time to let readers know about the returns my service produced in the month of August. Members of my service received 3 total trades which were all profitable. In fact, the gross return on maximum risk was over 100%. If a trader risked $1,000 on each of the 3 trades at the end of August his trading account would have grown to over $2,000. Year to date the success rate of trades is over 65%!

Here's to your trading success,
J.W. Jones
Options Trading Signals

Subscribers of OTS pocketed over 100% return in August alone! Review J.W Jones' track record at Options Trading Signals for a 24 hour 66% off coupon.


This material should not be considered investment advice. J.W. Jones is not a registered investment advisor. Under no circumstances should any content from this article or the OptionsTradingSignals.com website be used or interpreted as a recommendation to buy or sell any type of security or commodity contract. This material is not a solicitation for a trading approach to financial markets. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This information is for educational purposes only.

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