November 23rd, 2022

The Market Holiday Calendar Trade – Part Two

I mentioned yesterday that Thanksgiving week is historically bullish for stocks, but various Fed representatives seemed determined to squash any idea of a rally. Most recently there was a comment that labor demand is still outpacing labor supply. In other bearish news, every time China lifts covid restrictions, they report a new surge that again shuts down part of their economy. That will boost the dollar and a stronger dollar is ultimately not a good sign for the stock market right now.

Despite all of the news, the market rallied and the S&P 500 closed above 4000 for the first time since September.

In the good news category, Best Buy (BBY) revised its operating income forecast for the year to slightly over 4%, which is up from a previous forecast of 4%. Wall Street was encouraged by the news that the retailer is able to manage the ebb and flow of current market conditions.

The positive takeaway from yesterday’s price action came from the Nasdaq. Looking at the QQQ ETF, look at what the price did around the 20-day exponential moving average (purple line).

The ETF had been falling from its high 6 days prior and it came right down to the moving average and found support and bounced off that level today.

If we zoom out of that chart, we can see that the tech sector has been trading in a range of 261 to 294 since September. A bounce off the moving averages I mentioned happening near the top of this trading range could push the QQQ over a key resistance level of 294.60. However, if this falls apart we’re likely heading lower to retest those lows.

Alright, let’s get to part two of the market holiday calendar trade.

Yesterday, I gave you the basics of a calendar spread. Today we’re going to get into specifics of how to place a calendar trade on the SPX right before the market has a holiday. By the way, you can scale this down and use SPY instead to reduce the capital requirement needed.

Given the FOMC meeting minutes are being released at 2 pm, you may want to wait until about 2:30 pm EST before looking at this trade to make sure the market settles.

To construct this trade, we’re looking to sell an option that will expire the week after the holiday. In this case, we’re looking to sell the 2 DEC 22 option.

I then start looking out four weeks from that date to purchase the offset leg of the calendar spread. In this case, it would be 30 DEC 22. Since SPX options expire nearly every day now, you can fine-tune the expiration dates based on the next set of criteria.

For the rest of the example, I am going to use 16 DEC 22 as my offset leg for two reasons. Going out to 30 DEC 22, the trade had too high of risk (that I will write about below). The 23 DEC 22 is a good trade, but the cost to place the trade was $4905, so for the example, I’ll pull back the long expiration a little bit more to decrease the cost. Determining the expiration date for the long option is ultimately up to you, but I’ll cover what to look for in terms of risk vs reward.

We are going to sell the at-the-money option and buy the option at the same strike price. Now, the SPX closed yesterday at 4000, so I will use that level as an example. When placing the trade, use whatever the current at-the-money price is at the time.

Sell 2 DEC 22 4000 option
Buy 16 Dec 22 4000 option

If you notice, I used the word “option” rather than specifying a call or a put. The reason is the risk profile is the same and this sets up as a debit trade, therefore setting it up as a call or a put trade depends on which is cheaper. In this example, a call trade is a net debit of $37.40 ($3740) and a put trade is a net debit of $3320 ($3320), so let’s use puts.

This risk profile shows that if the trade closes at 4000 by December 2nd, the trade would be worth $2600 in profit. Highly unlikely, but we will use that in a second to come up with a profit target.

Let’s look at the break-even points at expiration. On December 2nd, the trade will be profitable as long as SPX stays above 3940 and below 4067. Keep in mind the market is closed on Thursday, half a day on Friday, and then we have a weekend in there. We need to close within the yellow circled area below.

Our profit target is 15 – 25% of the peak of the trade and our stop loss is if SPX hits either of the breakeven prices (3940 or 4067).

Should the SPX hit either of those breakeven numbers in a single day, your theoretical max loss on the trade would be -$302 on the downside and -$235 on the upside. Your profit target is around $390. This makes a better than 1:1 reward-to-risk trade.

Now, if you want to set a profit target a little lower – let’s say 10% of the peak instead – you may need to adjust the expiration date of the long option, but make sure that you’re getting close to a 1:1 or better reward-to-risk ratio by looking at your profit target and the one-day max loss at the breakeven points.

That’s it. I hope everyone has a great holiday week. That’s going to do it for FRDP this week. We will be back on Monday with a new article.

THANK YOU for reading this day in and day out.

If you have any questions, comments, or anything we can help with, reach us at any time.
Email: [email protected]
Phone: (866) 257-3008

Jeff Wood

Editor, Filthy Rich Dirt Poor

Trader, Options Testing Lab