I am assuming you have a working knowledge of what a calendar spread is. If you don’t, that is OK. Here is a great article from Investopedia. Here is a podcast/YouTube that lays out some of the trading strategies around the calendar spread.

I sold a reverse calendar spread for Tesla calls that are just out of the money. I blundered on this trade idea while searching for a normal calendar spread to buy. A normal calendar spread is when you sell an option that is expiring soonish and buy the same type of option at the same strike that is expiring at a later date. These work well when you think the underlying stock price will settle at a specific strike price or when you think the price for the shorter term option is too high when compared to the future dated one. When this happens option traders say, “We are selling the implied volatility in the short dated option.”

I had a list of stock symbols that I worked through to test to see if they set up well for calendar spreads. Tesla (TSLA) is on the list since there is almost always a ton of implied volatility in Tesla’s options. However, when I plugged Tesla’s prices into my model, I could not find a scenario where it was possible to make money buying a calendar spread. Not one. The price for the future dated option was always too high to make any money at all. When this happens, it only makes sense to look at getting on the other side of the trade. 

The Trade

Sell an at the money call of TSLA expiring in two weeks and buy a call with the same strike price that expires in one week. Exit both contracts when the short dated option expires or it profits 50%. This trade requires the highest level of trading approvals and enough available liquidity to hold it until the shorter term call expires.

This is a net credit transaction so I collected $386 per contract after commissions. 

Conditions For Success

I put the trade into Interactive Brokers’ trade analyzer to see what needs to happen for this to be a success. It says that I need at least a 1% move either up or down in the underlying stock price or a drop in the implied volatility of at least 15% to breakeven. If neither happens, it predicts a max loss of $38 per contract. The max gain would theoretically be the total premium collected, but I am not holding my breath for that. I will look to exit the trade if it goes up by 50%.

Also, I do not think it is probable that implied volatility will fall in the next week. Right now, it is at 45% with a historic average of 54.8%. Elon Musk tends to make headlines rather than staying quiet. Also, this trade is going to happen over the holiday season in December when implied volatility typically doesn’t change much. Therefore, I am going to focus on price movements as the main driver for this trade’s success.

I looked to see how many times TSLA ended a 5 trading day period either up or down 2% from where it started. This can give me a good baseline to start estimating the chances of success. I choose to go with 2% because a 2% move should land me solidly in the profit zone. 

Bayesian Percent Chances of Success

Historically, Tesla’s stock changed by at least 200 basis points 82% of the time. Seeing that it is the holiday season and most traders aren’t working, we should probably adjust this percentage down to around 60%. 

Conclusion

I have a 60ish percent chance of making money on this trade. If I don’t, the most I will lose is $38 a contract. I will look to exit if it is up $60 per contract. Let’s hope Elon does some buzzed christmas party tweeting…