Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A.

Sarkett
REAL WORLD

Here’s The Plan From Dan (Part 1)

Calendar Spreads
With Dan Sheridan
In the first part of a series based on a seminar on seminars: risk management. That alone makes him
option strategies with Dan Sheridan, we take a look different. Something else does, too: Dan Sheridan
at calendar spreads. doesn’t propose doing the education job in one or two
days, like many of his predecessors; his is an ongoing
program, with access to him anytime.
We’ve been taught that inventor Thomas Edison

O ptions and seminars go together like tried some 8,000 substances before chancing on
yin and yang, baseball and hot dogs, tungsten and finally being able to devise the revolu-
Abbott and Costello. Can’t separate tionary light bulb. There haven’t been that many
‘em, wouldn’t want to. Ten or more options seminars, but there have been quite a few.
years ago, some of the prominent seminars focused For those who stuck around long enough (and there
on straightforward strategies like put selling or ver- are those who have attended just about every option
tical spreads. In a surging NASDAQ market, these seminar given in the last 10 years), Sheridan just
one-day affairs served their purpose in helping retail might be the tungsten everyone has been looking for.
stock traders become more knowledgeable and com- But he might not seem like it, at least not at first. A
fortable with options. natural comedian, “Trader Dan” affects a regular
Then after the 2000–01 stock market crash and Chicago guy demeanor, because, as he would say, “I
with the equity markets in the doldrums came delta- am one.” Sheridan survived and thrived for 22 years
neutral strategies, making money in options when in the rough-and-tumble CBOE pits. His superb risk
stocks weren’t moving — timely and helpful. You management skills protected him and allowed him to
might have seen infomercials for these “wealth cre- grind out profits in markets both up and down, and
ation” seminars. those are the skills he wants to share. He’s generous
But not all the attendees were successful, nor even with his time and he tells the truth, flattering or not.
the gurus themselves. One notable “expert” expanded What more could you ask?
from giving seminars to managing an option trading Not just a market maker, though he’s got lots of war
fund. The fund lost 40% in six months before closing. stories from the pits to share and some good trading
There are and have been many, many other seminars tips, Sheridan successfully traded thousands of in-
and countless newsletters, and we’ve all been invited come strategy trades for his own account over the
by direct mail to attend or subscribe. Or both. Some past two decades (some 3,000 calendar spreads alone,
of us have, or at least been tempted. he estimates). He also mentored a number of traders
who went on to major success, some to head large
WHAT’S TO RISK? trading firms.
Now streaking across the option-trading-and-semi-
nar sky comes trader Dan Sheridan and his Options GENERATING INCOME
Mentoring series sponsored by OptionVue. He fo- Dan Sheridan brought his expertise to a recent Fu-
cuses on the missing dimension of most options tures Industry Association (FIA) meeting, where he
spoke on how to generate monthly income in the
options markets. Sheridan began the FIA session by
by John A. Sarkett goring a few sacred cows: “Make the odds work for
Copyright (c) Technical Analysis Inc.
 Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A. Sarkett

LEELA CORMAN

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A. Sarkett

you, not against you. Income generation is a superior strategy If you can follow directions and apply good management,
for 99% of traders.” you can make a business, Sheridan believes. “If I had a group
When trades are managed, not just put on and forgotten, of sixth-graders, and I taught them for two to three months, and
Sheridan says a trader can generate as much as 100% annual- they did what I’m telling them, they’d be successful. But too
ized. Some may scoff, he says, but he sees his best students many retail customers know too much. They bring in Fi-
doing it, grinding out 5% to 15% per month. (Not everyone bonacci, and Andrews pitchfork, and this and that, and pretty
does this, he says. Others make up to 7%, and those who can’t soon they are overthinking, and losing.”
follow instructions lose.) Sheridan believes if he can keep a It takes one other thing, too, Sheridan says — commitment.
new trader in the game for six months, earning a small “Some people say, ‘I’m going to try a calendar spread and see
percentage each month, learning the craft, adjusting the trades, what happens.’ This makes me crazy. Am I going to ‘try’ to
and keeping the enthusiasm high, he or she will make it as a open a beef stand in Chicago? No, it’s a business. It’s a
successful trader in the long term. commitment. You don’t give up on calendar spreads because
That’s the goal. To achieve it, Sheridan recommends a one doesn’t work. This does not provide the diversification or
portfolio of six or seven income strategies each month that don’t the time it takes to be successful.”
require a stock to move to be successful. He also believes in
staying small, keeping the account at $5,000 to $6,000 in capital
for six months, whether or not the trader can afford more.
Options and seminars go together like
He told the story of one trader who went large on a calendar yin and yang, baseball and hot dogs,
spread, lost big, got negative on calendar spreads in particular Abbott and Costello.
and options in general, and then quit.
“Why did you do it?” Sheridan asked about his decision to
trade big. INCOME STRATEGIES
“Because I could,” the trader, a Houston oilman, replied. In the FIA meeting and during a follow-up web seminar,
Sheridan believes if the individual had kept the faith, grinding Sheridan provided the meat and potatoes of his income strat-
out the profits month by month instead of going for the big score, egies. First, the definitions: “An income strategy is one where
he would most likely have been profitable and still be in the game. we don’t need the stock to move to make money.” These
“This is a craft,” Sheridan says. “We do it over and over.” strategies are also known as nondirectional, also known as
He says he now does everything in his power to slow down his delta neutral.
prospective traders, urging them to begin with paper-trading, then Best candidates for condors, double diagonals, and other
graduating to small trades. “Why do you think you can trade a neutral strategies, are channeling stocks, steady, sideways
$100,000 account if you can’t trade a $5,000 account? Learning movers, Sheridan says.
a craft takes time. We don’t say to our college sophomore, ‘Are Like a pilot looking over his aircraft before takeoff, here’s
you making money yet?’ We shouldn’t say that to new option how he looks for stock candidates:
traders who are learning their craft, either.”
Perhaps the best thing about Sheridan’s approach: It does 1 Volatilities. Less than 30 is the desired range.
not require a full-time commitment. Most of his traders work 2 Industry. Predictability. Kellogg’s stock would be
full-time, and he dissuades others with the available time from better than an unpredictable biotech startup.
becoming screen jockeys. Once up and running, he estimates 3 Price chart. If there was a 10% move last week or
his students spend only seven to eight hours per month at month, ask why.
options. “This is not daytrading,” he says. “Our best students 4 When to be there. If there are upcoming earnings
have full-time jobs.” These success stories have limit orders in dates or other special events, stay out of the market.
the markets that automatically actualize at key points. Sheridan
advises traders to become expert on the contingent order CALENDAR SPREADS
capability of their brokerage platform. A calendar spread is a strategy where the nearby option is sold
and a farther expiration bought — for example, sell May, buy
TRADING VEHICLES August. Calendars give the trader an edge in decay, probabili-
Dan Sheridan favors these income strategies. All are spreads ties, risk/reward ratios, and yields:
— no naked options:
Checklist for finding and filtering candidates
■ Calendars
1 Use a software program that has spread-searching
■ Double calendars capabilities.
■ Condors 2 Short side would have 25 to 30 days to expiration to
■ Double diagonals achieve maximum decay speed. (You want the option
you sell to lose value as fast as possible.)
■ Butterflies
3 Keep implied volatility (IV) on both sides: buy and sell

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Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A. Sarkett

sides is less than 30. That means the stock will prob- January, April, July, and October, but know your
ably move less than 30% in one year. Typically, large stock. Some report earnings in off months.
stocks like IBM, UPS, GE, AIG, and JNJ fit the bill here. 5 Avoid major news in a selling month — for example,
4 Keep the short side out of earnings months, typically an FDA event or mergers.

TRADER DAN ON GUERRILLA CALENDARS

Guerrilla Calendars When to take off for profit: When you’ve made 40% versus
what you paid. If you pay $0.50, you can take off for $0.70,
What are they? Sell one month and buy next month out. typically in two to four weeks.
Example:
Citigroup: $50 buy 10 November 50 calls and sell 10 October Volatility: Implied volatility (IV) in the low to middle volatility
50 calls range lasts one to one and a half years. If IV is at the high end of
the range, do the stress test in the analysis page of OptionVue.
Is this an income spread? Yes, we hope to make money by
the near-month time premium decaying faster than the second Industry: No oils, biotechs, or other volatile industries
month and the stock staying in the vicinity of the short strike.
Price: When trying to detect too much speed in underlying
How to find guerrilla calendars: Implied volatility is be- vehicle:
tween 14 and 28. You’re looking to pay as little as you can for
• Last week, was there more than a 5% move in one
the spread.
direction?
• Last month, was there more than a 10% move in one
Most desirable time to put on: 25–35 days from expiration.
direction?
• In the last three months, was there more than a 15% move
Are commissions important? You bet — $1 and under
in one direction?
should be the norm and not the exception.
• In the last nine months, was there more than a 25%–30%
in one direction?
Is execution important? Absolutely crucial! Don’t cave in
more than 0.05 off mid-prices, and be very patient at mid-
If you answered “yes” to any of these four questions,
prices before caving in.
consider waiting.
Is volatility an important consideration in guerrilla calen-
Earnings:
dars?
Yes, but not as important as in campaign calendars (calendars • No income spread in an earnings month. The exception
with more than one month between the near and far months). would be stocks with implied volatility under 25 in the
We can compromise and take implied volatilities in the middle last three earnings.
of the one-and-a-half-year implied volatility range. • No gap over 3%

How much should we pay? When we think of guerrillas we Skews: There should be no positive skew over four to five
think of paying $0.10–$0.50, which is great. There’s nothing points before you put on a position. If a four- to five-point skew
wrong, however, about paying up around $0.90. Remember the develops after you put on a position, take it off.
term guerrilla calendar refers to a one-month calendar where
our idea is to take a small dollar profit and run for the hills. News: Check the company website and some news services.
Here are the words you don’t want for income strategies:
Time premium: You want a time premium of short option “merger,” “takeover,” “split in the stock.”
more than 50% of long option.
Risk management: If you pay less than $0.40 for the guerrilla
Minimum I should receive for my short option: You want calendar, leave it alone till expiration day unless you take off
at least $0.30, which will usually be all time premium. Just for 40% profit or more any time before that. On expiration day,
remember the time premium of short should be at least 50% of take off the complete spread on both sides. Be careful if short
time premium of long. That means if you sell an option for option is in-the-money and time premium hits $0.05; you may
$0.30, you won’t pay more than $0.60! get exercised on the short call. If you pay greater than $0.40 for
the guerrilla calendar, take off when time premium of short
Picky execution: Never cave in more than $0.05 off mid- options hits $0.05 unless you take off for 40% profit or more
prices. Execution is crucial with these spreads. any time before that. —J.S.

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Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A. Sarkett

6 Aim for a long option near the low of its

implied volatility range. This gives it room
to rise, positive for the spread.
7 Sell in a near month, buy two to three
months out for opportunity to roll. (Roll-
ing is buying in the near month, and
selling a month farther out, or buying
in a nearer strike and selling a farther
strike.) The farther out the long option,
the lower its volatility should be. If the
volatility on the far option declines,
your asset declines and you lose.
8 Short option should bring minimum
$0.50.
9 If there is a positive skew (sell minus

OPTIONVUE
buy) that is greater than 6, investigate.
This is somewhat different from what
some teach — that is, sell high-volatility
near option against buying a lower-vola- FIGURE 1: GUERRILLA CALENDAR. On October 26, 2006, Sheridan sold 10 December 35 calls and bought
tility far option. The bigger the skew, 10 January 35 calls. The net debit on this position was $330.
the bigger the anticipated move. “If you
see a big skew, picture yourself on the
beach in Florida a day before a hurri-
cane is expected,” Sheridan says. “That’s
your reality. Do you really want to be
there?” If there is more than a skew of 6,
he suggests asking why. And probably
avoid that trade.

Place the trade

1 As a limit order at midpoints of buy
and sell
2 Wait five minutes. If you don’t get it,
give in a nickel, no more.

Manage the trade

1 99% of being successful is risk man-
agement. FIGURE 2: WHAT HAPPENED NEXT? BK went from 34.61 to 35.10 in the next 20 days. The trade was offset
2 For risk management points — that by buying 10 December 35 calls and selling 10 January 35 calls.
is, breakeven points — place your
adjustment orders in advance. At the very least,
have your adjustment plan in writing in advance. volatility range. For the second, avoid selling months where
Sheridan usually adjusts calendars by adding an- news can make the stock move — for example, earnings.
other calendar one strike up or down. Sheridan says that 99% of the time when there is a big move, it
is earnings-related. Since you can control the timing of your
Pain avoidance trade, stay out of the period that can whack you with change.
How do you get hurt with a calendar spread? There are two ways:
Adjustments
1 If volatility goes down, or If something can go wrong, it will. If the spread moves against
2 Stock moves big, up or down, thus squeezing the you, what can you do?
values of the short and long options together. 1 On the upside, volumes come down, put another
calendar spread on, higher strikes or
For the first, pick options that are low in their implied
2 Take your short strike and roll up or

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Stocks & Commodities V. 25:5 (18-26): Calendar Sprerads With Dan Sheridan by John A. Sarkett

3 Close the trade. Sheridan notes that the structure of Bought 10 January 35 calls 1.10
the calendar spread is such that even a fairly sizable
move creates only small losses. In a larger move, the Net debit: $0.31, plus $20 commissions = $330. If BK went to
worst case is quantified at the initial debit. If you put $1 million or zero the next day, the most Sheridan could lose
a calendar spread on for $0.40, say, that’s the most would be $330.
you can lose. What happened next? BK did not go to $1 million, nor did
it go to zero; instead, it went from $34.61 to $35.10 in the next
What about using a LEAP for the anchor, long option versus 20 days, and Sheridan offset the trade:
two or three months out? “The farther out, the more demanding
I am on volatility,” Sheridan says, meaning he wants lower and Bought 10 December 35 calls 0.75
lower volatility for the LEAP anchor. “If you’re long a LEAP and Sold 10 January 35 calls 1.15
volatility declines, it can make a grown man cry,” he quips.
Net credit: 0.40 minus $20 commissions = $380 net credit, $50
Calls vs. puts profit (Figure 2). Yield: 15.15% in 20 days. Small in dollars,
Should the strategist use calls or puts in a calendar? Calls trade yes, but large in yield, and Sheridan says there’s plenty of time
more, so Sheridan tends to favor calls. later to trade larger when you learn the craft.

Case study: The guerrilla calendar John A. Sarkett is the developer of Option Wizard Scan and
In Sheridan’s FIA seminar, he showed his personal variation Scan Wizard software (http://option-wizard.com).
on the calendar theme: a “guerrilla” or one-month calendar
spread example. (See sidebar, “Trader Dan on guerrilla calen-
dars,” for details.) He used Bank of New York (BK) as his
example (Figure 1). On October 26, he:

Sold 10 December 35 calls 0.79 †See Traders’ Glossary for definition S&C

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