BACKGROUND
The calendar call spread is a neutral options trading strategy that can generate profit when the security price remains stable or moves slightly. It involves buying and writing calls on the same security with an upfront cost. This strategy limits losses to the upfront cost, making it suitable for beginners. Understanding the impact of time on options prices is essential.
Important Aspects
Neutral Strategy
Suitable for Beginners
Two Transactions (buy calls and write calls)
Debit Spread (upfront cost)
Medium Trading Level Required
Also known as – Long Calendar Spread, Time Call Spread
WHEN SHOULD IT BE UTILIZED
The calendar call spread is employed to profit from minimal price movements in a security, making it suitable for a neutral outlook when anticipating stability in the price of a particular security. By establishing the spread, your maximum loss is capped at the initial investment, eliminating the risk of further losses in case of significant price fluctuations. This strategy is advisable if there are concerns about such scenarios.
INSTRUCTIONS FOR USE
Creating a calendar call spread is a straightforward process. You should sell calls on the relevant security with a short-term expiration date (preferably around a month). Simultaneously, you should purchase an equal number of calls on the same security with the same strike but a longer-term expiration date.
The calls with the longer expiration will be pricier due to their time value, resulting in a debit spread with an initial cost. While it's advisable to execute both legs simultaneously, you can opt for legging techniques if desired.
This spread, utilizing options with the same strike, constitutes a horizontal spread typically set up with at-the-money options. To lower the spread's cost, slightly out-of-the-money options with a higher strike can be used.
Below is an illustrative example of constructing this spread with at-the-money calls. This is a hypothetical scenario for educational purposes only and does not reflect actual market data or include commission fees.
If Company X stock is at $150, and you anticipate it will hold this value short-term:
At-the-money calls (strike $150) with a short-term expiration are priced at $2. Selling 1 contract of 100 options yields a credit of $200 (Leg A).
At-the-money calls with a longer expiration are priced at $4. Buying 1 contract of 100 options costs $400 (Leg B).
The calendar call spread is established with a net cost of $200.
Profit and Loss
The concept is to repurchase the written options just before expiration if the underlying security's price has remained unchanged. Subsequently, you can sell the owned options to potentially make an overall profit. Alternatively, you can allow the written options to expire without value. Illustrated below is an example of how this strategy could be implemented.
At the time of Leg A options' expiration, Company X stock is valued precisely at $150, resulting in their worthless expiration. The longer-term Leg B options that were purchased are still at-the-money, likely retaining most of their time value.
If each Leg B option is trading at $2.50, selling them all would yield $250. Deducting the initial $200 investment, a profit of $50 is realized.
If the Leg B options are trading at a higher price, the profits would be even greater.
Given the worthless expiration of Leg A options, the profit can be calculated as "Total Value of Leg B Options - Initial Net Investment".
Other options
Instead of using calls, the calendar call spread can be replicated effectively by using puts to form a calendar put spread. Another way to create the calendar call spread is by setting it up as a diagonal spread, purchasing calls with a lower strike compared to the calls you sell.
The fundamental concept remains the same when employing a diagonal spread, although it will require a slightly higher cost to establish, leading to greater profits if the underlying security's price experiences a slight increase.
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