Use Options to 'Time' Housing's Top

In fact, time, in the form of decay, is the main wind behind this strategy's back. Initially, the long and short puts offset each other -- meaning you aren't likely to make or lose money in the short term. But the position becomes more bearish (delta, a measure of the rate of change in an option's value relative to changes in the price of the underlying, increases) as time progresses, because the time decay, or theta, of the options accelerates at a faster rate as expiration approaches.

Ultimately, the near-term puts will expire, ideally worthless, and achieve their purpose of reducing your cost. Even if share prices don't decline, or if they rise slowly or gradually, one can hopefully sell enough cycles of the front-month options to completely pay for the cost of the longer-dated put options, leaving the position in outright long puts free or at no future risk.

Putting a Calendar Spread to Work

Many of the homebuilders, including Toll Brothers(TOL Quote), Hovnanian(HOV Quote), Centex(CTX Quote) and KB Home(KBH Quote), all sold off sharply Friday and saw heavy option volume amid fears that the strong jobs number would lead to more interest rate increases. At this point, most homebuilders' shares are some 10% to 15% off their all-time highs, but I'll use the numbers on Toll Brothers to illustrate a calendar spread.

On Tuesday, with the stock at $50, it was possible to sell the September 45 put for $1.25 and simultaneously buy the January 2007 LEAP put for $6.50, or a net debit of $5.25 for the spread. The cost of the spread -- in this case, $525 per unit -- essentially represents the position's maximum loss. Some situations, such as a takeover in which all the time value of the long-dated options would likely evaporate, could result in the maximum loss in a short period of time.