High Probability Option Trading:

Calendar Spreads

Steve Lentz

Director of Education and Research

OptionVue Research, Inc.

Disclaimer

Option trading can involve highly volatile returns and

unlimited risk. Option trading is not suitable for every

investor.

Overview

Introduction to Options and Graphical Analysis

Why Trade Option Spreads

The Role of Volatility

Advantages of Selling Premium

Calendar Spreads

Obtaining Candidate Stocks

Introduction to Options

and Graphical Analysis

Call Option – Right but not obligation to buy stock

at a certain price on a certain date

Put Option – Right but not obligation to sell stock

at a certain price on a certain date

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

IGEN

2/18/03

Calendar Spread

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

2/18/03

IGEN

Calendar Spread

2/18/03

IGEN

2/18/03

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

IGEN

Calendar Spread

2/18/03

IGEN

Today’s Risk/Reward Line

2/18/03

Risk/Reward Line for 16 Days Away

IGEN

2/18/03

IGEN

1

st

Standard Deviation of

Possible Price Outcomes
Based on Last Month of Trading

2/18/03

Risk/Reward Line for Expiration in

32 Days

IGEN

Why Trade Option Spreads ?

To Obtain Favorable Risk/Reward Ratios

2/18/03

IGEN

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IGEN

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IGEN

Long 100 Shares of Stock

Long 1 Call Option
16 Days Out

IGEN

2/18/03

Long Stock

1:1 Risk/Reward Ratio

IGEN

2/18/03

Long Option

Negative Risk/Reward Ratio

On Normal Sized Moves

IGEN

2/18/03

Long Option

Positive Risk/Reward Ratio

Only on Big Moves

Option Spreads

Help Create Positive Risk/Reward Ratios

On Normal Sized Moves

IGEN

Option Spreads

Positive Risk/Reward Ratio

Only on Normal Moves

2/18/03

Advantages of Selling Premium:

Adopt the role of insurance company

Time is on your side

Through risk management, the long-term

odds can be in your favor

The Role of Volatility

SV

IV

IMPLIED VOLATILITY (IV)

Measures the volatility of the underlying asset
implied by current option prices

Higher IV Means More Time Premium to Sell

STATISTICAL VOLATILITY (SV)

Measures how much the price of the asset itself has
bounced around recently

Higher SV Means a Wider Standard Deviation of

Possible Price Outcomes

Percentile Rankings

Knowing a

Good Premium Selling Situation

Expensive vs. Inexpensive

Overvalued vs. Undervalued

Expensive = High IV Percentile

Inexpensive = Low IV Percentile

IV Percentile Rankings

0

30%

70%

100%

INEXPENSIVE

EXPENSIVE

Overvalued = High IV/SV Ratio

Undervalued = Low IV/SV Ratio

Knowing a

Good Premium Selling Situation

Sell Expensive and Overvalued Options

Purchase Inexpensive and Undervalued

Options

Calendar Spreads for the

Option Trader

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

2/18/03

IGEN

Calendar Spread

Last Change Trade

Bid Ask T.Prem Trade Bid Ask T.Prem Trade

IGEN

2/18/03

Calendar Spread

Last Change Trade

Bid Ask T.Prem Trade Bid Ask T.Prem Trade

IGEN

2/18/03

Calendar Spread

Theta:

Daily drop in dollar value of an option

due to the effect of time alone. Theta is

dollars lost per day per contract.

Last Change Trade

Bid Ask Theta Trade Bid Ask Theta Trade

IGEN

2/18/03

Calendar Spread

$5.26 - $2.17 = $3.09 Position Theta

IGEN

2/18/03

Today’s Risk/Reward Line

IGEN

2/18/03

Risk/Reward Line for 16 Days Away

IGEN

2/18/03

Risk/Reward Line for Expiration in 32 Days

IGEN

2/18/03

87% Probability

50% Probability

Position Requirements

Last Change Trade

Bid Ask MIV Trade Bid Ask MIV Trade

2/18/03

IGEN

Calendar Spread

Stock Position:

100 shares

X $79.33 = $7,933

Margined Position:

$7,933 X 50% = $3,967

Last Change Trade

Bid Ask Theta Trade Bid Ask Theta Trade

2/18/03

IGEN

Calendar Spread

Calendar Spread:

Buy 1 June 40 Call at $4.50 = $450 Debit

Sell 1 May 40 Call at $2.45 = $245 Credit

Total Requirement = $205 Debit

IGEN

2/18/03

$205 Requirement

$3967 Requirement

IGEN

2/18/03

Calendar Spread

Variations

IGEN

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Calendar Spread

IGEN

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IGEN

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IGEN

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Calendar Spread

IGEN

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IGEN

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Calendar Spread

IGEN

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IGEN

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Volatility Profile for

Good Calendar Spreads

#1…A Large

Horizontal Volatility Skew

Bid Ask MIV Trade Bid Ask MIV Trade

Last Change Trade

2/18/03

IGEN

Calendar Spread

#2…Overvalued

Option Chains

#2…Inexpensive

Option Chains

Obtaining Candidate Stocks

High Probability Option Trading:

Calendar Spreads

Steve Lentz

Director of Education and Research

OptionVue Research, Inc.