In the world of options, a calendar-spread trade involves selling a short-term option and buying a longer-term option with the same strike price. Let's look at such a trade on McDonald's stock.
Usually you can make this trade 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 that case, they would use puts.
McDonald's Stock Today: Setting Up A Calendar Spread
With McDonald's stock recently trading around 254, setting up a calendar spread with a 255 strike price gives the trade a neutral outlook.
Selling the Sept. 16-expiration 255 call option will generate around $320 in premium. Buying the Sept. 23 call with the same strike, or 255, costs around $415.
That results in a net cost for the trade of $95 per spread. That's the most the trade can lose.
The estimated maximum profit is $200. But the potential gain could vary depending on changes in implied volatility.
The idea with the trade? If MCD remains around 255 for the next week, the sold option will decay at a faster rate than the bought option. This activity allows the trader to close this play for a profit.
When To Exit The Trade
The break-even prices for the trade in McDonald's stock are estimated at around 248 and 262, 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. Also, I would set a profit target of 25% and set a stop loss if MCD stock breaks through either 248 or 262. For a trade like this I would risk not more than 2% to 3% of my capital.
Always 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
