Short Time Spreads

Random Walk Trading by J.L. Lord.

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The video ran for 1h 31 m.

When the market has you spooked and you’re not sure what to do, what do you do?

A short time spread.

There have been concerns about a possible double-dip recession. It would be hard for an eternal optimist to find good news for the stock market. Many contrarian investors have made a living as the markets climb a wall of worry because they find solace in all the negative news. Given what is going on, traders are wondering what strategy is appropriate.

Good traders have a mental list of the strengths and weaknesses of their trading strategies. Each strategy has its own concerns when the market is falling.

It seems like a long straddle is an ideal strategy for those who think volatility will spike. It will be difficult to make money if the markets spike higher. If volatility continues to increase, a significant loss, temporary or real, can occur if the short straddle is used. If you pick the right direction, a vertical spread will lower your volatility exposure.

The age old dilemma of what strategy to trade when the markets are making you nervous is solved by a short time spread. The easiest way to describe a short time spread is to look at the long time spread.

To take advantage of time decay, a long time spread is the simultaneous sale of a short term option and purchase of the same option in a back month.

The initial risk of a time spread is the same as most spreads.

A long time spread profits from the short near-term option decaying at a faster rate than the further out option.

There are two rules for maximizing profits. Time spreads become more profitable when they are near the money, and they are worth the most when they are at an ATM.

Success depends on the stock’s volatility and how close to the underlying strike price it is. Being too far off from the correct strike will result in a loss.

The value of a time spread can be determined by looking at the front month’s option chain time values, since each leg of the spread shares the same strike and will have intrinsic values that cancel each other out. The profit or loss of a time spread is similar to an option time premium.

The short time spread will allow the trader to take advantage of the high volatility. We have a breakeven/profit range for our long time spread. It’s a good trade if you’re sure your option will last. Remember our initial premise. When you expect more of the same, what should you do? A short time spread is similar to a long straddle but without the same level of exposure. We could have called it The Thinking Man’s straddle.

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