Options traders can create income by employing a calendar spread strategy. So in today's example, we'll look at designing this trade in Goldman Sachs stock.
Goldman is struggling to hold its gains since rebounding off its mid-July low of 277.84. As a weekly chart shows, the money-center bank failed to make much progress above its downward-sloping 40-week moving average. GS also trades sharply below its 10-week line, a sign of weakness.
In a calendar spread, we can set this up by selling a short-term option and buying a longer-term option with the same strike price.
Usually this is done with monthly options. But you can also set this trade in Goldman Sachs stock with weekly options.
Traders typically use call options unless the trade has a bearish bias, in which case they would use puts.
Goldman Sachs Stock Today: How A Calendar Spread Works
With Goldman Sachs stock recently trading around 290, setting up a calendar spread at 290 gives the trade a neutral outlook.
Selling the Oct. 21-expiration put option with a 290 strike price recently generated around $1,200 in premium, and buying the Nov. 18 290 put cost around $1,640.
That results in a net cost for the trade of $440 per spread, and that is the most the trade can lose.
The estimated maximum profit with these trades is $750, but that could vary depending on changes in implied volatility.
The idea with the trade is that if GS stock remains around 290 for the next few weeks, the sold option will decay at a faster rate than the bought option, allowing the trade to be closed for a profit.
When To Close This Trade
The break-even prices for the trade are estimated at around 268 and 316, 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.
In this Goldman Sachs stock trade, I would set a profit target of 20%. Also consider setting a stop loss if GS stock breaks through either 268 or 316.
For a trade like this I wouldn't risk more than 2% to 3% of my capital.
According to the IBD Stock Checkup, GS ranks sixth in its group. Goldman stock has a Composite Rating of 47, an EPS Rating of 59 and a Relative Strength Rating of 56.
Please remember that options are risky and investors can lose 100% of their investment.
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
