From David Riveria from Delta Neutral Trading comes a lesson on Option Trading...Calender Spreads and Time Decay. Learn more about David and his site Delta Neutral Trading.
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When traders speak of putting on calendar spreads, they normally refer to buying the further month options and selling the closer month option. While I can not argue with this, it is not best for all options.
I am going to be general in this article because prices change and I don’t want to cause confusion.
For out of the money options, you might want to consider doing the opposite. Buy the close month and sell the further month. This is because the theta is advantageous to you if you are buying the front month. The further the months are from each other, the more you have an advantage. Also, figure out the price per day of the option. Which option costs more and which is cheaper per day. You can find options that are equal distance away in strike from the futures but one option is 3 times cheaper per day than the other.
For the at the money options, the regular calendar spreads are the way to go. For strike prices that are far out of the money, the reverse calendar spread is better. One reason is the theta advantage. Another is the price per day.
So keep your eyes open for out of the money options and check their price per day and theta and compare them to different months. If you are looking at different months, make sure that the month you are thinking of selling, is the same amount of strike prices away or more from the underlying, as the one you sell. Meaning, if you buy an option that is 5 strikes away from the underlying, the one you sell, should be at least 5 strike prices away from the underlying. This is so if there is a big move, both options will be in the money at roughly the same time.
David Rivera has traded commodities and options for one of the largest cash trading firms in the world. He has written a course on futures options techniques.
You can find out more about this concept at: Delta Neutral Trading
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I'm not sure I agree with the "price per day" concept. It would work if Theta and time had a linear relationship but it does not. Especially as the option moves closer and closer to expiration it decays more rapidly:
http://www.optiontradingtips.com/options101/time-decay.html
Peter.
Thanks. Brief but good explanation for a beginner like me.