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Calendar Call Spreads...

Calendar Call Spread Profit Loss Graph

Calendar Calls are a bullish strategy. A conservative investor will look to trade Calendar LEAP spreads by purchasing an In the Money (ITM) 1-year or 2-year LEAP and then selling At the Money (ATM) or Out of the Money (OTM) near term calls against the LEAP (diagonal spread). Basically, the calendar call spreads strategy is a leveraged covered call position since the investor will pay less for the LEAP than they would to own the stock. A profit is realized if the stock is trading above the Break Even point at expiration. Since the ITM LEAP will always cost more than the premium on the short call, the position is entered at a debit. An investor can also trade horizontal spreads where the strikes of the two options are the same, but have different expiration dates.
Calendar Spread Options Buy a long call at a given strike price (lower strike price).
Sell a near month call zero or more strikes above #1 call.
Calendar Spread Options The net investment is the net debit (difference in premiums).
The maximum risk is the net debit (difference in premiums).
Calendar Spread Options The maximum profit is realized if the stock is trading at the short strike price at short term expiration. Maximum profit is equal to the value of the long option at short term expiration minus the net debit.
The break even point is the point at which the value of the bought call will equal the net debit. A profit is realized at any price above the break even point.
The return calculations for the Calendar Call Spread are:
% Assnd = Max. Profit ÷ Net Investment
% Assnd = (Long Call Value - Net Debit) ÷ Net Debit
% Dnsd Prot = Premium Income ÷ Buy Price of Long Contracts
% Unch. = [Long Call Value (at short-term exp. w/ current stock price) - Net Debit] ÷ Net Debit
% Dnsd Prot = Short Call Bid ÷ Long Call Ask
Example: Stock XYZ at $49.31 per share.
Buy JAN 1 Year Out 40 strike call for $13.70
Write (Sell) the Near Month 55 strike call for $0.80
% Assnd = (Long Call Value - Net Debit) ÷ Net Debit
% Assnd = (17.90 - 12.90) ÷ (13.70 - 0.80) = 5.00 ÷ 12.90 = 38.8%
% Dnsd Prot = Short Call Ask ÷ Long Call Bid
% Dnsd Prot = 0.80 ÷ 13.70 = 5.9%
% Unch. = [Long Call Value (if stock stays at $49.31 at short term exp.) - Net Debit] ÷ Net Debit
% Unch. = [13.02 - 12.90] ÷ 12.90 = .68 ÷ 12.90 = 1.0%
Max. Risk = Net Debit = 13.70 - 0.80 = $12.90
Max. Profit = Long Call Value - Net Debit = 17.90 - 12.90 = $5.00, if stock is at $55.00
Long Call Value = Black Scholes value of the long call when the stock price is at the higher strike.
Break Even = Stock Price when long call value is equal to net debit = $49.17
Write Cycles = Months to Exp. of Long Call ÷ Months to Exp. of Short Call
Write Cycles = 12 ÷ 2 = 6
Determining the Long Option Value for % Return If Assigned and % If Unchanged:
When the short-term option is near expiring in-the-money, it is usually more profitable to buy stock on the open market to cover the obligation rather than exercising the long-term option. This is because the long-term option will most likely have some time value left, as a result, it can be more profitable to sell the long-term option rather than exercise it. So, when PowerOptions shows the % Assnd. and % Unch. for these trades, we show the returns using the Black-Scholes value of the long option to approximate the price an investor could sell the option for.
To verify the returns that appear on the SmartSearchXL or the OneStrike Tools for Calendar Spreads, simply click the More Info. (little blue button) on the far left of the corresponding row. Select "Calculators" from the More Information Menu and then select "Black-Scholes" for the "Buy Option". For the Long Call Value in the % Assnd calculation, enter the short option strike price value in the "Stock Price" box. Then click the "Use These Hypothetical Numbers" button to calculate the theoretical price of the long option. Scroll down to the date of the short term expiration (In our example, August 20th) to view the calculated value of the long option at short term expiration.
To verify the % Unch. value, follow the same procedure but enter the current stock price into the "Stock Price" box on the Black-Scholes calculator tool. This will calculate the theoretical long option value at short term expiration if the stock was unchanged.
Advantages of this strategy:
The calendar call spreads strategy is a BULLISH strategy, the profit can only be realized when the stock price is above the break even point.
Buying the LEAP in lieu of the stock can generally allow the stock to be controlled at a discount. In this case the LEAP is purchased for 40% of the stock price, with very little time premium. For options that are nearer term than LEAPs, this advantage will apply less.
Losses are limited to the net debit.
No stock is actually owned. (uncovered position).
One of the principal advantages of this strategy is that one can potentially write the near term calls many times before the expiration of the bought call that expires further out in time. Therefore, the investors' cost for the long call can be greatly reduced with the many writes.
Cautions with this strategy:
If the stock goes very high gains are limited to the difference in strikes minus the debit.
If the stock goes very high immediately there is the possibility of actually loosing money if the near term call is assigned. Therefore, it is important that the difference in strike prices be greater than the initial net debit to assure a profit if the spread is assigned early during the first write.
Practically speaking, it may be difficult to write a near term call for every write cycle.


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Calendar Calls - Calendar Spreads - Calendar Spread Options