Long Call Calendar Spread Options Strategy

Submitted by admin on Thu, 11/25/2021 - 22:36

This approach combines a positive long-term perspective with a neutral or bearish short-term outlook.


A long call calendar spread is made up of a short one call option and a long second call option with a later expiry.
The approach is most typically used with calls that have the same strike (horizontal spread), but it may also be used with calls that have various strikes (diagonal spread).

Outlook


Look for a stable to slightly dropping stock price during the life of the near-term option, followed by a rise higher over the life of the long-term option, or a sudden increase in implied volatility.

Summary


This approach combines a positive long-term perspective with a neutral or bearish short-term outlook.
If the underlying stock stays the same or falls throughout the duration of the near-term option, it will expire worthless, leaving the investor free to own the longer-term option.
If the strike prices of both options are the same, the approach will always demand a premium to open the position.

 


EXAMPLE


Short 1 near AAPL $160 call

Long 1 far AAPL $160 call


GAIN MAXIMUM


Unlimited


LOSS MAXIMUM


Payment of the net premium


Motivation


The investor wants to save money by buying a longer-term call option.

Variations


Two calls with the same strike but separate expiration days are used in this approach.
The profit/loss profile of a diagonal spread comprising two calls with different strikes and expiration days would be slightly different.
The fundamental notions, on the other hand, would continue to apply.

Maximum Loss


If the two options attain parity, the maximum loss will occur.
This might happen if the underlying stock dropped to the point where both options were worthless, or if the price increased to the point where both options were deep in the money and trading at their inherent value.
The loss in either situation would be the premium paid to take out the position.

Maximum Gain


If the underlying stock is at the strike price of the expiring option when the near-term option expires, the maximum gain will occur.
The expiring option would have more intrinsic value if the price were higher, while the longer-term option would have less value if the stock were lower.
After the near-term option has expired worthless, the investor is left with only a long call position, which has no profit ceiling.

Profit/Loss


The possible profit during the life of the near-term option is restricted to the degree that the near-term option depreciates in value faster than the longer-term option.
When the near-term option expires, the strategy becomes a long call with an endless profit potential.
The maximum possible loss is the premium paid to open the position.

Breakeven


Because the options have different expiry dates, the level at which the strategy breaks even is determined by the underlying stock price, implied volatility, and time decay rates.
Breakeven at the expiry of the longer-term option would occur if the stock was above the strike price by the amount of the premium paid if the near-term option expired worthless.
However, if the position is closed out for a credit equal to the debit paid when the position was launched, it might happen at any moment.

Volatility


All other things being equal, an increase in implied volatility would be tremendously beneficial to this approach.
Longer-term options, on average, are more sensitive to swings in market volatility, resulting in a larger Vega.
Be mindful that near-term and long-term options may or may not trade at the same implied volatility.

Time Passes


In the beginning, the passage of time would have a beneficial influence on this technique, all other things being equal.
Once the near-term option has expired, the strategy becomes a long call whose value will be reduced over time.
As the expiration date approaches, the rate of time decay of an option generally increases.

Assignment Danger


Yes.
While early assignment is feasible at any time, it is most common for calls when the stock goes ex-dividend.
If the assignment is exercised early, utilizing the longer-term option to cover it would need setting up a short stock position for one working day.


Also, be aware that if a stock is involved in a restructuring or capitalization event, such as a merger, takeover, spin-off, or special dividend, usual expectations for early execution of options on the stock may be entirely thrown off.

Risk of Expiration


Slight.
If the near-term call option (the short side of the spread) is executed before it expires, the longer-term call option will remain as a hedge.
If the longer-term option is in-the-money when it expires, it may be executed on the investor's behalf by their brokerage company.

Comments


Because of the difference in time to expiry, the Theta, Delta, and Gamma of these two call options are different.
Obviously, the near-term call is subjected to more temporal decay, resulting in a higher Theta.
The near-term call has a smaller Delta but a greater Gamma, which is counterintuitive (if the strike is at-the-money).
This means that if the stock rises rapidly, the near-term call's value approaches that of the more costly longer-term call.


When the previous short-term option expires, a typical version of this technique is to write another short-term option until the underlying stock moves considerably or the longer-term call approaches expiration.