You might be familiar with the covered call options strategy, which can potentially generate and combine selling calls against the stock or ETFs an investor already owns. The calendar spread allows you to do the same thing without owning the underlying. So there is less cash at risk in hopes of generating income. The calendar spread is designed to profit from the time erosion or time decay that occurs in near-term options. If the underlying moves away from the current price in either direction then the call spread starts to decline in value. In this blog, we are going to see the details about what a calendar call spread is and how it is constructed. We also are going to see how to trade calendar call spread and the calendar call spread options strategy.
This blog covers
What is a calendar spread?
What is a calendar call spread?
Calendar call spread calculator
Trading calendar call spread
Calendar call spread options strategy
What is a calendar spread?
Entering a long and short position on the same underlying asset at the same strike price but with different expiration dates is called a calendar spread. That means buying and selling a position on the same underlying asset at the same strike price having different expiration dates is known as calendar spread. It is sometimes referred to as a horizontal spread.
What is a calendar call spread?
An option strategy of buying a long-term call option while simultaneously selling a short-term call option with the same strike price but the different expiry date is called a calendar call spread.
This is different from a vertical spread which consists of buying and selling an option of the same type and expiration but different strike prices. So vertical spreads are called vertical spreads because everything is the same except the strike prices while calendar spreads are sometimes called horizontal spreads because the only difference is the expiration cycle.
Calendar spread calculator
There are various calendar spread calculators available which give you the value of the calendar spread upon inputting specific terms. Calendar Spread Calculator is used to see the projected profit and loss over time.
The max profit for a bull call spread can be calculated as follows:
Max Profit =
(Call option strike price sold – Call option strike price purchased) – Premium Paid for a bull call spreadTrading calendar call spread
We have seen what calendar spread is and what calendar call spread is. Now we are going to discuss how to trade calendar call spread and calendar call spread options strategy. We are going to discuss the specifics of trading a calendar call spread.
A long call calendar spread profits from a slightly higher move up in the underlying stock inside of a given range. As stocks are slowly starting to rally higher, you need to trade either directional spreads or trade some of these calendar spreads.
Calendar call spread options strategy
A typical calendar spread strategy is nothing but buying a longer-term contract and selling or shorting a nearer-term option with the same strike price.
Strategy: - Sell Front Month OTM Call and Buy Back- Month OTM Call of same strike prices.
You can setup this strategy in a following way:
According to this strategy first you are going to sell a front month Out-Of-The-Money call option. That front-month option is going to be a little bit closer to where the market is trading. So days out is probably anywhere between 20 and 35 days. After this, you buy a more expensive back-month option. So that the next monthly option that is out, at an Out-Of -The -Money call spread at the exact same strike price. Here you are going to be trading two different months, but pinning the exact same strike price.
What's the risk in this Calendar call spread options strategy?
Your risk in these calendar spreads is limited to the width of the net debit paid for the spread. If you paid a debit of ₹150 for your calendar, your risk is limited to just that ₹150, you cannot lose any more money than that.
What is the profit potential of the Calendar call spread options strategy?
It can be very hard with these strategies because of the decay in the back month option that you are long to pinpoint an exact probability of profit. Ideally, what you are looking for though is to target your profit at the value of the sold front-month contract. If you sold the front-month contract for ₹50 and you bought the back-month contract for ₹150, you’re looking to profit somewhere around ₹50 or that decay in the value of that front-month contract. Profit is going to be maximized if the stock settles at the strike price at the expiration. The closer you get to expiration, the faster that profit will start to materialize.
With calendar spreads, breakeven points are so hard to calculate because there is no single calculation to use. You must analyze the trade first before placing an order.
An increase in volatility (Vega) would have a positive impact on this strategy considering that everything else being equal. Volatility tends to show a greater boost in the value of back month options that are long. Whereas increased volatility has negative impact on front month options that are short.
We suggest you to close calendar spreads completely at front month expiration whoever possible.
Conclusion
The calendar spread is designed to profit from the time erosion or time decay that occurs in near-term options. The calendar spread is different from a vertical spread. Profit is going to be maximized if the stock settles at the strike price at the expiration. This way you can use the calendar call spread option strategy to maximize your profits.
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