Sample Payout Diagram
Legs
- Buy Call, Strike A, for Near Expiration
- Sell Call, Strike B, for Far Expiration
Strategy Description
A Short Calendar Call Spread, also known as a Short Call Time Spread, involves buying a call option in the near-term expiration and selling a call
on the same strike for a longer-term expiration. The strategy will bring in a net credit at the time of the trade because an option with a
longer period of time before expiration has more premium. You will also be net short implied volatility because the longer-term option has a
larger Vega.
In the diagram above, strike A and strike B are considered to be the same strike price. You'd be buying the call at strike A in the near-term expiration
and selling the call at strike B in the far-term.
An Example
Let's say the stock price is currently $100. The call on the $100 strike for an option with 30 days to go until expiration might be $6. The call for the $100 strike
for an option with 60 days left might be $10. If you buy the near-term and sell the far-term, your net premium received is $4.
When to Use It
There are two cases when using this strategy might be advantageous:
-
When you feel that the stock will have a big move in either direction away from the strike, or
-
If you feel the implied volatility in the far expiration will have a significant drop prior to the
near-term option expiring.
Let's start by analyzing the first part. Originally, you are buying and selling at-the-money calls. At-the-money options have the most time premium
relative to other strikes. As the stock price moves farther and farther away from the strike, these options will lose more and more time premium
until they reach parity. If the stock price drops extremely far from the strike, both options will have significantly less time premium and approach being
worthless -- at which point, you'd be left with the initial premium you collected at the time of the trade. If the stock has a very big move to the upside,
then both options will be priced closer to intrinsic value. If that is the case, you will be able to close out your position for a cheaper cost because the
value of the time premium will shrink and approach zero.
The second way to profit from the calendar spread is if the implied volatility (IV) decreases. Usually, there is a skew in implied volatility between option
expirations. The calendar spread tries to take advantage of that skew and wait for implied volatility to converge. Typically what you would see is that the
longer-dated option has a higher implied volatility than the shorter-dated one, because there is more uncertainty as you go out further in time. So the
longer-dated option not only decays over time, but it also has a downward sloping implied volatility. As options get closer to expiration, the IV might drop
because there is more certainty. If the far-term option's implied volatility drops, and the value of the far-term option decreases by more than the value of
the near-term option, it will result in a net profit before the near-term option expires.
Break-Even Points at Expiration
The break-even is dependend upon several variables, because the far-term option is still active at the time of the near-term expiration. You can approximate
the break-even points based on time decay, implied volatility, and stock price movement, but choosing an exact break-even point is not an essential feature
of this strategy.
Max Gain
The maximum possible gain is the credit you receive when you establish the position. This would be achieved if the stock price drops so low that both
options are rendered worthless, or if the stock price rises so high that their values converge at parity.
Max Loss
The maximum loss is difficult because each option has a different expiration date. When the near-term option expires, the far-term option still has
time value and that time value will be dependent upon the implied volatility at that point. If the implied volatility increases but the stock price
remains near the strike or below, the difference in value between the options will expand, and your risk will become greater.
