Yesterday, we detailed the use of calendars into the ADBE earnings event where you sell the event month options and buy a farther month at a much lower volatility. In doing so you target the implied move in in the direction you are playing. ADBE is higher this morning on an earnings and guidance beat:
The software company earnings an adjusted 66 cents per share for its latest quarter. That was 5 cents above estimates, while revenue was slightly above forecasts, as well. Adobe also gave upbeat guidance for the current quarter as digital media sales surge.
Into the event, we looked at a put calendar for those that were bearish and a call calendar for those that were bullish. Here was the call calendar:
Buy the ADBE (89) March/April 95 call calendar for .50
- Sell 1 March 95 call at .45
- Buy 1 April 95 call for .95
The stock was higher by about 5% last night and we got this question from a subscriber on trade management:
What would you do tomorrow with the Mar 95 sold call coming due?
Here was my response:
So what you do next is dependent on whether you want to stay long afterwards. If that’s the case you close the March call and roll that short strike up in April (e.g. buy to close the march and sell the April 100s) If you just want to take the trade as is you can close the entire thing for a profit tomorrow. As far as when to do it? This is a tough one to answer not knowing exactly how the stock will open, but remember that April call will be worth alot more on the open if the stock is around 95 than the close if it’s around 95, so the longer you can be patient the more profitable the trade will be, but that’s only if the stock isn’t wild after the open. If it’s wild and moving all over the place you obviously don’t want to risk the stock moving too much too fast from 95 after the open as it takes away some of the profits in either direction. (it’s short deltas above 95 and long deltas below 95). Either way it’s a nice trade and how nice it is depends on how the stock acts in the morning, if it settles in around 95 you have a lot of nice options for it.
We unknowingly tagged team the question because I forgot to cc Dan, but his response was essentially the same:
Generally we will see where the stock opens, if near our strikes then try to make an assessment if it were to settle in near the implied move. If this happens then the short strike about to expire should start to lose most of its extrinsic premium, leaving the difference between the march and april as more profit on the trade. At this point the trade works if the stock is a bit below $95, and not too far above it. You would not want to see the stock start to rip too fast above 95 though, some at some point you will need to make a decision.
So let’s look at where this trade stands. With ADBE at 94.50 this trade is worth about 1.70, which is a great profit on the .50 risked yesterday. So now the debate on management becomes whether this is a trade simply for the event of if this was a core holding idea where you now have the chance to stay in ADBE stock for next to no risk.
Let’s first cover the point about the extrinsic value of the March 95 calls. Those March 95 calls are slightly out of the money and currently trading .75. If the stock was 94.50 on today’s close, those will be worthless. That means that if the stock settles in here for the rest of the day, this trade gets much more profitable. But how do you decide how patient you can be? Pretty simple actually. The April calls are about 50 deltas. If the stock were to fail here and go lower you have some cover as that .75 in March short calls will be worthless at the end of the day (you collect that .75) so the stock could go lower by about 1.50 today and this calendar would essentially still be worth 1.70.
As far as those wanting to stay with the stock, you want to be patient as well and wait for the 95 calls to decay as much as possible before rolling and selling an upside call in April, perhaps the 100 calls. That can be done for a credit, and if done for a credit more than .50 by the end of the day (e.g. closing the March calls for .10 and selling the April 100 calls at .70 then you would then own the April 95/100 call spread for a credit. That’s not bad as you can;t lose and can make up to $5.