[Options] Taking a Slower Approach to a Healthcare Rise

We chatted about the trade in the video above and you can see how we came to doing a Call Calendar spread in the healthcare sector ETF $XLV.

Here's the chart for $XLV:

In the current market environment, I feel that if $XLV is going to follow through on the upside, it's likely to happen slowly—a slow-motion breakout.

But with a call calendar spread, even if we get the speed of the move wrong, we can still profit.

Here's the Play:

I like buying an $XLV March/September 145-strike Call Calendar Spread for an approximately $4.85 net debit. This means I'll be short the March 145 calls and long an equal amount of September 145 calls. The debit I pay today represents the most I can lose:

With calendar spreads, there are two ways we can win.

1. If $XLV trades up to $145 before our short March call options expire worthless (March 15th is expiration day), then I'll close the entire spread down for a small profit. We don't want to continue holding if $XLV trades above $145 because as you can see in the PnL graph above, our potential PnL begins to shrink as we trade further away from the 145 strike (thanks to the short calls we're holding). The amount of profit will depend on how close we are to March expiration day -- the closer we are, the more potential profit as the short option will have less premium for us to cover.
2. If $XLV does not trade up to/through $145 before March 15th, then our short calls will expire worthless and then we're left with just the long September 145 calls. This means we'll have the potential for unlimited profits on calls that we now own at a discount (thanks to the premium we collected on those short March calls). I like that!

For those of us who enjoy the game, we could even earn extra credits (and therefore reduce our open risk) by continuously "rolling" our short calls into the next monthly expiration each time the short options decay in value to below 25-50 cents. This requires a bit more active management and likely means we'll just keep rolling the short calls until we get to $145 and then take off the whole position without ever just being in the position of a straight long call. (If you have questions on this, shoot me an email!)

So that's how we win.

Of course, we need to have a plan of action if we're wrong. If $XLV sees a closing price below $139 per share at any time during our hold (whether I've rolled short options, let short options expire, or nothing at all), I'll exit the entire position to salvage whatever is left in the premium of the long calls. Depending on the timing of when this happens, we might still escape with a small profit in this campaign. But it's likely we'll simply suffer a small, manageable loss. My kind of risk!

If you have any questions on this trade, please send them here.

If you missed last week’s video Jam Session, you can catch a replay on Stock Market TV.

~ @OptionsSean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free! Or give us a call to learn more: 323-421-7910.