Call Calendar Spread Options Strategy
Call calendar spreads are a popular options trading strategy used by traders to take advantage of the difference in time decay between two call options with different expiration dates. In this article, we will dive into the details of call calendar spreads, including how they work, how to trade them, and some potential advantages and disadvantages to consider. Whether you’re an experienced options trader or just getting started, this article will provide valuable insights into this powerful trading strategy.
What Is a Call Calendar Spread
A call calendar spread is an options trading strategy that involves buying a longer-term call option and selling a shorter-term call option at the same strike price. The aim of the strategy is to profit from the difference in time decay between the two options.
The longer-term call option typically has a higher premium than the shorter-term call option due to the additional time value. By selling the shorter-term call option, the trader collects a premium that helps to offset the cost of buying the longer-term call option.
If the underlying asset remains stable or trades within a specific range, the value of the longer-term call option should remain relatively constant over time. At the same time, the value of the shorter-term call option will gradually decrease as time passes, due to time decay. This creates an opportunity for the trader to buy back the shorter-term call option at a lower price than they sold it, thereby locking in a profit.
The maximum profit potential for a call calendar spread occurs when the underlying asset price is at the strike price of the options at expiration of the short-term option. In this scenario, the value of the longer-term option will be higher due to its longer time to expiration, while the value of the short-term option will be near zero. The difference between the two values represents the profit.
However, if the underlying asset moves too far away from the strike price, the trader may experience a loss. If the price of the underlying asset rises above the strike price, the value of the longer-term call option may increase, but the value of the shorter-term call option will also increase due to the price movement, resulting in a potential loss. Similarly, if the price of the underlying asset falls below the strike price, the value of both the long-term and short-term options may decrease, resulting in a potential loss.
Call Calendar Spread Example
Let’s assume that the current price of stock XYZ is $100 per share, and we want to execute a call calendar spread with a strike price of $100.
Here are the steps involved:
- Buy the longer-term call option: We buy a call option on XYZ that expires in 6 months with a strike price of $100. Let’s assume this option costs $10 per share.
- Sell the shorter-term call option: We sell a call option on XYZ that expires in 1 month with a strike price of $100. Let’s assume this option costs $5 per share.
The net cost of the trade is $10 – $5 = $5 per share.
If the price of XYZ remains around the strike price of $100 at expiration of the short-term option, the value of the longer-term call option should remain relatively stable, while the value of the short-term call option will decrease due to time decay. This creates an opportunity for the trader to buy back the short-term call option at a lower price than they sold it, thereby locking in a profit.
For example, if the value of the short-term option decreases to $3 per share at expiration, the trader can buy it back and realize a $2 per share profit. If the trader repeats this strategy every month until the expiration of the longer-term option, they can potentially realize multiple profits.
However, if the price of XYZ moves significantly away from the strike price, the trader may experience a loss. For example, if the price of XYZ rises above $105 at expiration of the short-term option, both the long-term and short-term options may increase in value, resulting in a potential loss. If the price of XYZ falls below $95 at expiration of the short-term option, the value of both the long-term and short-term options may decrease, resulting in a potential loss.
How to Trade a Call Calendar Spread
Here are the steps involved in trading a call calendar spread:
- Choose an underlying asset: The first step is to choose an underlying asset that you want to trade. This could be a stock, an ETF, or another financial instrument.
- Determine the strike price: Next, you need to determine the strike price at which you want to trade the options. The choice of strike price for a call calendar spread depends on the trader’s outlook for the underlying asset. Often, the trader will choose an at-the-money strike price.
- Choose the expiration dates: For a call calendar spread, you will need to choose two different expiration dates. The first expiration date should be for the shorter-term call option, which you will sell. The second expiration date should be for the longer-term call option, which you will buy.
- Buy the longer-term call option: Using a trading platform or a broker, you will buy the longer-term call option with the later expiration date.
- Sell the shorter-term call option: At the same strike price, sell the shorter-term call option with the earlier expiration date.
- Monitor and manage the trade: Once you have opened the trade, monitor it carefully and consider using stop-loss orders to manage potential losses or adjusting or closing the trade.
When trading a call calendar spread, it’s important to carefully consider the underlying asset, strike price, and expiration dates, based on your trading strategy and outlook for the market.
How to Adjust a Call Calendar Spread
Adjusting a call calendar spread involves making changes to the position in order to manage potential losses or maximize profits. Here are some common ways to adjust a call calendar spread:
- Adjust the expiration dates: You can adjust the expiration dates of your options to reflect your updated outlook for the stock. For example, if you think the stock price will increase more slowly than you initially expected, you can roll the short call option to a later expiration date to capture more time decay.
- Adjust the strike prices: If the stock price has moved significantly since you opened the position, you may want to adjust the strike prices of your options to reflect your updated outlook.
- Close the position early: If the price of the underlying asset moves sharply in one direction, you may choose to close the position early to limit potential losses. This can be especially important if the shorter-term call option is in the money and there is a risk of early assignment.
- Add more contracts: Another way to adjust a call calendar spread is to add more contracts to the position. This can help to increase potential profits if the trade is going well, or to reduce potential losses if the trade is going against you.
It’s important to carefully consider the potential risks and benefits of each adjustment before making a trade.
Pros and Cons of Call Calendar Spreads
Call calendar spreads can be a useful strategy for options traders, but like any trading strategy, they have both advantages and disadvantages. Here are some pros and cons of using call calendar spreads:
- Potential for profit in a range-bound market: Call calendar spreads can generate profits when the price of the underlying asset remains relatively stable or moves within a certain range, making them useful in a variety of market conditions.
- Limited risk: The risk of a call calendar spread is limited to the initial cost of the trade, which is typically less than the cost of buying a long call option outright.
- Flexibility: Call calendar spreads can be customized to suit a trader’s individual preferences and risk tolerance, allowing for greater flexibility in trading.
- Market volatility: Call calendar spreads can be impacted by market volatility. If the stock price experiences a significant move in either direction, it could result in losses for your position.
- Potential for early assignment: If the shorter-term call option in a call calendar spread is in the money and the option holder decides to exercise early, the trader may be assigned early and required to sell the underlying asset at the strike price, which can lead to unexpected losses or missed profits.
- Complex strategy: Call calendar spreads involve buying and selling options with different expiration dates, which can make the strategy more complex than other options trading strategies. This complexity can make it more difficult for novice traders to implement the strategy effectively.
In summary, call calendar spreads can be a useful strategy for generating income and reducing risk in options trading. However, traders should be aware of the potential limitations and risks associated with this strategy, and carefully consider their trading goals and risk tolerance before implementing it.
The Bottom Line
In conclusion, call calendar spreads can be a valuable addition to any options trader’s toolkit. By taking advantage of the difference in time decay between two call options with different expiration dates, this strategy offers a way to generate income while minimizing risk. As with any trading strategy, there are risks involved, but with proper planning and execution, call calendar spreads can be an effective way to achieve your trading goals.