Current market conditions give great opportunities for options traders. Recent volatility, as well as the fear prevailing in the market means that volatility (historical, forecast and implied) is high relative to recent levels.
Today I’m looking at a calendar spread on BHP. This is a bearish play (aligned with my view on the market and BHP) with limited risk.
I’m looking at buying 100 $28 puts expiring on 26 July 2012 (76.5c) and selling the same number of puts expiring on 28 June 2012 (52.5c). Each option contract is over 100 shares in BHP. Total cost is $2,400 plus commission. My risk is limited to my initial investment so there should be no margin requirements. My expectation for placing this trade is that BHP will decline and trade around $28 during June. I’ll look to close the trade on or before expiry of the June option.
Below is a graph showing the estimated profit on 28 June 2011 (when the short option expires) for a range of BHP prices. Ive assumed $60 brokerage (the cheapest discount brokerage available). Click on the graph below to open in a new window.
Maximum profit is c.$9,000 is BHP is exactly $28 at expiry. The spread is profitable for BHP prices between $25.25 and $31.50. More technically minded reader might note there is a potential edge from buying the July option on a volatility of 41.1% and selling the June option on a volatility of 44.6%.
Advantages of this trade
- Limited risk of $2,460 with potential profit of up to $9,000.
- The spread is profitable over a wide range ($25.25 to $31.50). So even if I’m wrong on my opinion of BHP I still might do OK.
- BHP options are amongst the most liquid so I’m more likely to get fair prices when entering and exiting the trades.
I’m going to treat this trade as a paper trade, and will conduct a post-trade analysis after it closes.
PS Please read the disclaimer before trading any action.
On Monday 21 May following this post the spread was trading at c.21c. This will form the entry price for the purpose of tracking the trade and undertaking post-trade analysis.