Calendar Spreads

The most common form of calendar spread involves the purchase of a longer-term option and the sale of an equal number of shorter-term options of the same type and strike. Most spreads, (with the exception of spreads on underlying securities with very high carrying costs) will initially be placed for a debit because of the greater time value of the longer-term options. This strategy can potentially be used to generate income and/or to reduce/increase the cost basis of an eventual stock purchase/sale. Using calls, this strategy has similarities with covered call writing / buy-writes.

For use when investor anticipates:

• Slowly rising or flat market
• Price of the underlying security to be slightly below the strike at short option's expiration

Financial Characteristics:

• Maximum Loss: Net Premium Paid. In addition, client may have to exit the long early (via sale or exercise) to cover an assignment on the short, losing the opportunity for further gains
• Maximum Gain: Unlimited, once the short option expires. If the short call is assigned on or before expiration, the client will have a short position whose losses, should the stock price rise, will outweigh any gains made on the long option
• Ideally, the cost basis of the long call is eventually reduced to zero, and the investor begins to get paid to hold his long position

Objectives:

• Generate income from the short positions
• Benefit from the greater rate of time decay of short-term options vs. longer-term options
• Potentially realize any gains from a movement in the underlying security after the near-term option expires

EXAMPLE - Calendar Spread

An investor feels that stock XYZ, which is trading at 60, will trade at this price for at least the next 3 weeks, and then might rally. The investor could sell the June 65 Calls (trading at 2.10), and buy the July 65 Calls (trading at 4.10). The net debit to the account would be 2, or $200. If XYZ is below 65 at June expiration, the short expires worthless, leaving the investor with a simple long position in the July 65 Calls that he can maintain, simply sell, or spread off with other July options. The short-term breakeven price cannot be calculated exactly. The long-term breakeven price (after the June expiration) is calculated by adding the net debit of the spread to the strike price of the long option.