OPTION GAME :- CALENDAR PUT SPREAD

INTRODUCTION

The calendar put spread closely resembles the calendar call spread, with both strategies designed to leverage time decay for potential profit by anticipating a security's price stability. While the calendar call spread involves calls, this approach employs puts.

In order to set up this spread, you should both write and purchase put options for the identical underlying security. This constitutes a debit spread that involves an initial cost, serving as the maximum potential loss as well. This strategy is beginner-friendly, although grasping the concept of time decay is essential. Further information provided below.

The Main Highlights

• Neutral Strategy

• Suitable for Beginners

• Two Transactions (buy puts and write puts)

• Debit Spread (upfront cost)

• Medium Trading Level Required

• Also known as – Long Calendar Spread with Puts, Time Put Spread

When to Apply ?

A calendar put spread is ideal for a neutral outlook when you expect an underlying security to remain stable for a short period. It limits potential losses to the initial cost, making it appealing if you fear a significant price movement.

Development

To establish a calendar put spread, write near-term puts on a security you think won't move in price and buy the same number of puts with a later expiration date. Execute both transactions simultaneously or use legging techniques. The spread uses options with the same strike, typically at the current trading price or slightly lower to reduce cost.

Example: Company X stock at $50. Write 1 contract of at-the-money puts expiring in 1 month for $200 credit (Leg A) and buy 1 contract of at-the-money puts expiring in 3 months for $400 (Leg B). Net cost of the spread is $200.

Financial Performance

Profit in options trading is driven by time decay, with the rate of decay being fastest as options near expiration. The goal is for written options to lose value faster than bought options.

If the underlying security price remains unchanged, written options expire worthless while owned options should cover the initial investment and yield a profit.

It's challenging to predict exact profits without movement in the underlying security, but maximum loss is known upfront as the spread's initial cost.

In case of a price drop, liabilities from written options can be offset by the increase in value of bought options.

If options are assigned, you can exercise options owned or sell them to cover liabilities. If the underlying security price rises, written options expire worthless, limiting loss to the initial investment. Bought options may still have value, allowing for potential recovery through selling.

Options

Consider using calendar put spreads as an alternative to calendar call spreads. You can adjust the spread by purchasing higher strike puts, creating a diagonal spread. While this may cost more initially, it can lead to higher profits if the security's price drops slightly.