Have you ever thought about trading long calendars but were perplexed as to how to put them on? In addition, how do you choose the strike price, or prices for double calendars? How do you choose how far out to trade them, or whether to give yourself a roll in the trade? Where do you start? In my opinion, the best place to start is with your own market bias. If that means utilizing charts to determine where the underlying might be headed, then so be it. If you think the underlying will fall, choose a put calendar strike below the current market price. If you think the underlying will rally, choose a call calendar strike above the current market price. If you have no directional bias, then an at-the-money calendar might be your best bet. Remember, a calendar is worth the most when the front month expires with the underlying sitting at your short front-month strike. Thus, directional bias does play a factor in the success of the calendar.

I speak volumes on calendars because I love the probability of return and the risk/reward characteristics they provide. For instance, the average ATM calendar has about a 44% probability of paying 2-to-1 on your investment. This is a long calendar play, so you are paying a debit for it. Try getting those odds in Vegas. If you don't believe me, take a look! As you can see, the $1.88 debit, or in terms of real dollars, $188.00, that we paid for the Aug./Sep 125 calendar pays out $180.00 for one calendar on August expiration if the underlying stays at the strike price. More importantly, this position makes money as long as the underlying settles between $121.20 and $129.10 at expiration.

Now let's dig a little deeper. We analyzed doing a one month Aug/Sep 125 calendar in the SPY. But how do we know whether a one-month or two-month calendar is more appropriate for our needs? First of all, you have to look at the cost of the calendar itself. In our first example, the one-month calendar traded for a $1.88 debit. That is pretty pricey relative to the two-month calendar with a possible roll embedded. Take a look at the same strike calendar 125 in the SPY but this time between August and October.

In this example the two-month calendar costs us $2.70. Is this calendar more expensive? Take a second to think about this. What does the two-month calendar offer us? It offers us the chance to roll our position forward into another calendar. This means that once August expires we can sell the September 125 strike against our already long October position. When we look at the $2.70 price with another roll embedded, the calendar actually costs $1.35 per month since we have a roll opportunity for September. By doing the two-month calendar, we have lowered the cost basis on our calendar from $1.88 for the one-month to $1.35 for the two-month. Now, as with any calendar, the position is a short Gamma position whether it is a one-month or two-month calendar, so the position provides the greatest profit if the underlying moves to our short strike and begins to lose money if the underlying moves too far away from our strike price. In order to determine how far the stock can move from the strike price, just use the Analyze Tab as shown above and set your slices to Break Even at Expiration +1 date. As always, happy trading, and stay profitable.

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.