Short Call Calendar Spread
Strategy Motivation
The Short Call Calendar Spread is a strategy for profiting from an increase in volatility of an underlying asset while anticipating a subsequent decrease or moderate fluctuation in its price.
Construction of the Strategy
To construct the Short Call Calendar Spread, you buy a near-term call option and sell an equal number of longer-term calls with the same strike price.
Brief Description
The Short Call Calendar Spread is a strategy for profiting from a big fluctuation in the price of an underlying asset. In most cases, an at-the-money option is selected when opening the position.
Since the near-term call option has a lower premium than the longer-term call option with the same strike price, the strategy results in a net credit. The maximum potential profit is the net option premium received, which is only possible if the time value of the longer-term call option decays faster than that of the near-term call option.
If the asset's price experiences a significant rise or fall, the near-term and longer-term call options will tend to converge, resulting in a loss of time value. Closing the gap between the options' values can lead to maximum potential profit.
However, if the asset's price fluctuates too much, the cost of buying back the longer-term call option may exceed the near-term call option's revenue, resulting in a loss.
If the price of the underlying asset remains unchanged, the near-term call option will quickly lose its value, while the longer-term call option will not lose as much time value, leading to potential losses.
After the near-term call option expires, you can either close the longer-term call option or construct a new strategy based on market conditions.
It is noteworthy that holding the longer-term call option after the near-term call option expires is not recommended. This is because it will become a naked call option with unlimited loss potential and no further profit potential.
Gain & Loss
Breakeven
The short call calendar spread has two breakeven prices: one above the strike price and one below. The prices at which the short call's time value equals the spread's original price are the breakeven prices.
However, the exact breakeven prices cannot be known because the short call's time value depends on the underlying asset's volatility.
Maximum gain
The potential maximum gain of a short call calendar spread is the money you receive when you open the spread. This profit is realized when the underlying asset price is either far above or below the strike price on the expiration date of the long call.
This is because the difference between the two calls approaches zero when the underlying asset price moves sharply away from the strike price, and you keep the full amount you received for the spread.
Max loss
If the long call is still open, the potential max loss would occur when the underlying asset price equals the strike price of the calls on the expiration date of the long call. Because the short call has the maximum time value when the underlying asset price equals the strike price, and the long call expires worthless when the underlying asset price equals the strike price at expiration.
However, suppose the long call expires worthless, and the short call remains open. In that case, the potential max loss of a short call calendar spread is unlimited.
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
