Calendar Call Spread
The calendar call spread is also known simply as a calendar spread or a time spread, and it involves buying and selling call options of the same strike price but having different expiration dates. This spread is usually made to take advantage of differences in time decay and volatility between the options of the different expiration months.
The Calendar Call Spread Setup
Suppose you consider a stock, that of the XYZ company quoted at $100. You would like to position in a call calendar spread when you do one of the following:
- Bought a call for a relatively longer period; with a strike of $100; expiring after six months and paid as a premium is $6.
- Sold a shorter duration call that is expiring next month on the same striking price of $100 and have a premium for the same which was $2.
Who Should Consider It
This strategy is best suited for traders who can expect the underlying stock to remain stable in the short term but could rise as the option close to its expiration date. It’s particularly ideal for markets that are experiencing low to moderate volatility.
In a calendar call spread, the trader capitalizes on the accelerated time decay of the shorter-dated option compared to the longer-dated option. Since the near-term call option sold will lose value faster than the long-term call option bought, the setup benefits from the passage of time, provided the stock price remains around the strike price.
Determination of a specific breakeven point for calendar spreads is challenging because it is contingent on the value of the remaining long call at expiration time for the short call. The strategy will break even if the amount of profits from the decay in time for the short-term option equates to the time decay for the long-term option, adjusted for shifts in implied volatility and movement in price for the underlying asset.
The sweet spot for this strategy is when the stock price is at or near the strike price when the short-term option is close to expiration. This positioning means that the short option will either expire worthless or be bought back at a lower price, thus maximizing the benefit from the initial premium received.
Theoretical maximum profit of a calendar call spread is not capped as long as the stock continues to rally significantly after the near-expiration short-term option; however, practically it is limited to the case where at that option’s expiration the stock price is close to the strike. All the following profits will depend on remaining time and the intrinsic value of the long-term option.
The maximum loss occurs if the stock price falls significantly, causing both options to expire worthless. This loss is limited to the net cost of establishing the spread (i.e., the difference between the premiums paid and received).
The major risks are that the stock moves a lot away from the strike price, thereby degrading the spread, and also volatility spikes up, which can make the short option costlier than the long option.
A crucial element of the calendar call spread is time decay, or theta. Since it is a selling short-term option and buying long-term option, the overall position benefits from rapid time decay in the nearer expiration option if the stock price does not move.
Volatility may have some effect on implied options, depending on the movement direction. More typically, however, an increase in implied volatility has a net beneficial effect for longer-dated option, where short-dated would be negatively impacted. If this is followed with a downward spiral of volatility then the same short-dated will be decreased along with an equally or better hurt to the long-dated position.
A calendar call spread is an advanced strategy, which implies having to monitor and manage pretty closely. It is suitable for sophisticated traders who understand the nuances of the options world. It provides a simple, efficient means for profiting from time decay and differences in volatility between options that expire at different times under relatively stable conditions.