Trade Desk (TTD) has had an amazing finish to 2020, rising from 400 to above 900.
Coming into Monday, the implied volatility for TTD stock was 48% which is close to the lowest levels we have seen in the last 12 months. When volatility is low, calendar spreads can be a nice addition to an option portfolio because they are long volatility trades.
A calendar spread is an income trade that involves selling a short-term option and buying a longer-term option of the same type with the same strike price. Usually this is done with monthly options, but it can also be done with weekly options. Traders typically use call options unless the trade has a bearish bias, in which case they could use puts.
The Trade Profits From Time Decay
Let’s see how a calendar spread might look on TTD stock.
With TTD stock now trading around 855, setting up a calendar spread at the 855 strike gives the trade a neutral outlook. Selling the Jan. 15. 855 call option will generate around $4,250 in premium and buying the Feb. 19 855 call will cost around $8,050.
That results in a net cost for the trade of $3,800 per spread and that is the most the trade can lose. The estimated maximum profit is $2,600 but that could vary depending on changes in implied volatility.
The idea with the trade is that if TTD stock remains around 855 for the next few weeks, the short option will decay at a faster rate than the long option, allowing the trade to be closed for a profit.
The break-even prices for the trade are estimated at around 795 and 930, but these can also change slightly depending on the impact of changes in implied volatility. For this reason, calendar spreads are considered a more advanced strategy and not recommended for beginners.
For a trade like this, I would set a profit target of 20% and I would set a stop loss if TTD stock breaks through either 795 or 930.
I would not risk more than 2-3% of my capital.
TTD is due to report earnings on February 4th, so there is no earnings risk with this trade.
It’s important to remember that options are risky and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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