Calendar Call Spread

The Calendar Call Spread, often simply called a calendar spread or a time spread, is an options trading strategy that involves buying and selling call options with the same strike price but different expiration dates. This strategy is typically used to exploit differences in time decay and volatility between options with different expiration months.

The Setup

Suppose you're considering the stock of company XYZ, currently priced at $100. You might set up a calendar call spread by:

Buying a long-term call option with a strike price of $100 and an expiration date six months from now, for which you pay a premium of $6.
Selling a short-term call option with the same strike price of $100 but expiring in one month, receiving a premium of $2.

Who Should Consider It

This strategy is ideal for traders who expect the underlying stock to be relatively stable in the short term but to potentially increase as the longer-dated option approaches its expiration. It’s particularly suitable for markets experiencing low to moderate volatility.

Strategy Explained

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.

Breakeven Process

Determining a precise breakeven point for calendar spreads can be complex because it depends on the value of the remaining long call as the short call expires. Generally, the strategy breaks even when the profits from the time decay of the short-term option offset the cost of the long-term option's time decay, adjusted for any shifts in implied volatility and underlying asset price movement.

Sweet Spot

The sweet spot for this strategy occurs when the stock price is at or near the strike price as the short-term option approaches expiration. This positioning allows the short option to expire worthless or be bought back at a lower price, maximizing the benefit from the initial premium received.

Max Profit Potential

The maximum profit for a calendar call spread is theoretically uncapped if the stock price rises significantly after the short-term option expires, but practically it is often limited to the scenario where the stock price is near the strike price at the short option’s expiration. Profits then depend on the remaining time and intrinsic value of the long-term option.

Max Loss

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).

Risk

The primary risks include the stock moving significantly away from the strike price, reducing the effectiveness of the spread, and unexpected increases in volatility, which could increase the price of the short option more than the long option.

Time Decay

Time decay, or theta, is a crucial element of the calendar call spread. Since the strategy involves selling a short-term option and buying a long-term option, the overall position benefits from the rapid time decay of the nearer expiration option if the stock price remains stable.

Implied Volatility

Changes in implied volatility can have a complex impact on this strategy. An increase in implied volatility generally benefits the longer-dated option more than it affects the shorter-dated option. However, a decrease in implied volatility could harm the position, reducing the price of both options but impacting the longer-dated option more severely.

Conclusion

A calendar call spread is a sophisticated strategy that requires careful monitoring and management, ideal for traders with a nuanced understanding of options dynamics. It offers an efficient way to benefit from time decay and volatility differences between options expiring at different times, particularly in a stable market environment.