Short Call Calendar Spread Options Strategy

Submitted by admin on Thu, 11/25/2021 - 22:42

This approach takes use of the differences between near-term and longer-term call options.


Buying one call option and selling a second call option with a later expiration is selling a call calendar spread.
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


During the life of the near-term option, the investor is hoping for either a sharp rise in either direction in the underlying stock or a sharp move lower in implied volatility.

Summary


This approach takes use of the differences between near-term and longer-term call options.
The technique suffers from time decay if the stock remains stable.


If the underlying stock rises or falls dramatically, both options will move closer to their intrinsic value or zero, closing the gap between their values.
If the strike prices of both options are the same, the strategy should always get a premium upon entering the trade.

 

EXAMPLE

  • Long 1 AAPL near 160 call
  • Short 1 AAPL far 160 call

 

GAIN MAXIMUM


Received a net premium


LOSS MAXIMUM


Unlimited


Motivation


The investor anticipates profiting from a significant increase in the stock price.

Variations


A horizontal spread is a strategy that comprises two calls with the same strike but separate expirations.
The profit/loss profile of a diagonal spread comprising two calls with different strikes and expirations would be slightly different.
The fundamental notions, on the other hand, would continue to apply.

Maximum Loss


If the underlying stock remains unchanged, the maximum loss will occur.
If the stock is at the strike price of the expiring option at the initial expiry, that option will expire worthless, but the longer-term option will keep most of its time premium.
In such case, the loss would be equal to the cost of repurchasing the longer-term option less the premium paid when the position was opened.
If the near-term option expires worthless and the investor does nothing, the technique becomes a naked call, and the potential loss is unlimited.

Maximum Gain


If the two choices attain parity, the maximum gain 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 gain would be the premium obtained when the position was opened in either situation.

Profit/Loss


The potential profit is restricted to the degree that the shorter-term option increases or loses value faster than the longer-term option.
The possible loss during the life of a near-term option is a consequence of implied volatility, and a sudden jump higher might result in significant losses.
However, if the position is kept past the near-term option's expiration date, the strategy becomes a naked call, with no additional profit potential and the potential for endless loses.

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.

Volatility


All other things being equal, an increase in implied volatility would be exceedingly detrimental to this approach.
Longer-term options, on average, are more sensitive to swings in market volatility, resulting in a larger Vega.
However, keep in mind that near-term and long-term options may trade at different implied volatilities.

Time Passes


All other factors being equal, the passage of time would have a severely unfavorable influence on this technique.
As the expiration date approaches, the rate of time decay of an option generally increases.

Assignment Danger


While early assignment is feasible at any time, it is most common when a call goes ex-dividend.
If the assignment is exercised early, utilizing the near-term option to cover it (assuming it hasn't expired) would need opening a short stock position for one business 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


When the longer-term option expires, this approach faces an expiration risk.
After the near-term expiration, when the strategy becomes a naked call, the largest risk for this approach arises.
In comparison, the chance of getting allocated unexpectedly when the longer-term option ultimately expires appears to be minor.


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.