I like to trade calendar spreads. Right now my favorite underlying to use is SVXY, a volatility-related ETP which is essentially the inverse of VXX, another ETP which moves step-in-step with volatility (VIX). Many people buy VXX as a hedge against a market crash when they are fearful (volatility, and VXX. skyrockets when a crash occurs), but when the market is stable or moves higher, VXX inevitably moves lower. In fact, since it was created in 2009, VXX has been just about the biggest dog in the entire stock market world. On three occasions they have had to make 1 – 4 reverse splits just to keep the stock price high enough to matter.
Since VXX is such a dog, I like SVXY which is its inverse. I expect it will move higher most of the time (it enjoys substantial tailwinds because of something called contango, but that is a topic for another time). I concentrate in buying calendar spreads on SVXY (buying Jun-14 options and selling weekly options) at strikes which are higher than the current stock price. Most of these calendar spreads are in puts, and that seems a little weird because I expect that the stock will usually move higher, and puts are what you buy when you expect the stock will fall. That is the topic of today’s idea of the week.
Using Puts vs. Calls for Calendar Spreads
It is important to understand that the risk profile of a calendar spread is identical regardless of whether puts or calls are used. The strike price (rather than the choice of puts or calls) determines whether a spread is bearish or bullish. A calendar spread at a strike price below the stock price is a bearish because the maximum gain is made if the stock falls exactly to the strike price, and a calendar spread at a strike price above the stock price is bullish.
When people are generally optimistic about the market, call calendar spreads tend to cost more than put calendar spreads. For most of 2013-14, in spite of a consistently rising market, option buyers have been particularly pessimistic. They have traded many more puts than calls, and put calendar prices have been more expensive.
Right now, at-the-money put calendar spreads cost more than at-the-money call calendar spreads for most underlyings, including SVXY. As long as the underlying pessimism continues, they extra cost of the put spreads might be worth the money because when the about-to-expire short options are bought back and rolled over to the next short-term time period, a larger premium can be collected on that sale. This assumes, of course, that the current pessimism will continue into the future.
If you have a portfolio of exclusively calendar spreads (you don’t anticipate moving to diagonal spreads), it is best to use puts at strikes below the stock price and calls for spreads at strikes which are higher than the stock price. If you do the reverse, you will own a bunch of well in-the-money short options, and rolling them over to the next week or month is expensive (in-the-money bid-asked spreads are greater than out-of-the-money bid asked spreads so you can collect more cash when rolling over out-of-the-money short options).