Calendar Spread
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A calendar spread is a horizontal spread that uses calls or puts and is short-term
neutral, but is generally longer-term bullish or bearish. The position is created
by purchasing a longer-term option and simultaneously selling a shorter-term option
with the same strike price. The trader will typically use a slightly OTM strike
price in anticipation of either a moderate or sideways move in the underlying stock
through expiration of the first option. In the event the short option expires worthless,
the trader can sell another near term option with the same strike price to create
a second calendar if their outlook is still neutral or sell an option with the same
expiration to create a vertical spread if a more modest directional move is expected.
Finally, the trader can simply remain long the further out option if the outlook
is more bullish or bearish.
Calendar spreads are limited risk positions with unlimited reward potential to the
upside for the call calendar and limited, but high potential reward to the downside
for the put calendar. In the event the underlying makes an adverse move, the short
option will be assigned and the trader can exercise the long option to exit the
position in the underlying. Since the strike prices are the same, the risk is limited
to the initial debit paid when creating the calendar.
Assume that it is January 9th and you are longer-term bullish on Microsoft Corporation
(MSFT)**, but believe it will trade sideways for the next month or
two. You can purchase a longer-term call and partially off-set the cost of this
call with by selling a short-term call with the same strike price. MSFT closed at
26.86 and you evaluate a calendar spread that purchases a Jul 27.50 call and simultaneously
sells a Feb 27.50 call. Figure 1-A displays the risk graph for this option strategy,
but it’s important to note that the existence of two expiration dates makes
the reward capped when there is potential for it to be unlimited. In the event the
short call expires worthless, the trader will be left with a risk graph similar
to a long call position.
The Jul 27.50 can be purchased for 1.20 and the Feb short call can be sold for 0.35.
The net debit to the account is $85 ((1.20 – 0.35) x 100 = 85), which is the
maximum loss for the position, less commissions. If MSFT is trading higher than
27.50 at Feb expiration, the short call will be assigned and the trader must sell
100 shares of MSFT at 27.50. The individual can either purchase MSFT in the market
to cover this short position or exercise the Jul 27.50. If exercise is selected,
the net value of the stock transaction is 0 ((27.50 – 27.50) x 100 = 0), less
commissions.
In the event MSFT is trading below 27.50 at Feb expiration the short call will expire
worthless and the Jul 27.50 will likely have some extrinsic value. If the longer-term
outlook remains bullish, the Jul call can be held as a single long call position.
On Feb 17th, MSFT actually closed at 26.70 and the short call did indeed expire
worthless. The Jul 27.50 was selling for 0.90; 0.05 more than the initial debit
for the combined position.
CALL CALENDAR EXAMPLE SPECIFICS**
Long 1 JUL MSFT 27.50 Call @ 1.20
Short 1 FEB MSFT 27.50 Call @ 0.35
MSFT @ 26.86
Net Debit: 0.85 or $85 ((1.20 – 0.35) x 100 = $85)
Maximum Risk: $85 ((1.20 – 0.35) x 100 = $85)
Maximum Profit: Unlimited to the upside beyond the breakeven IF
the Feb option expires worthless
Breakeven: 28.35 (27.50 + 0.85 = 28.35)
Margin: Required for short contract
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CALL CALENDAR STRATEGY REVIEW |
Strategy = Buy a long-term call option and sell a shorter-term
call option with the same strike price
Market Opportunity = Look for a market that is short-term range-bound
(through expiration of the short option) with a moderately bullish bias in the long-term
Maximum Risk= Limited to the amount paid for the combined calls
Maximum Profit= Limited to the upside beyond the breakeven (best
determined with software analysis tool). If the short call expires worthless, the
new risk graph will resemble a long call risk graph.
Breakeven= Call strike price + net debit
Margin= Required. The amount is subject to your broker's discretion.
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