Stratégies Options - Calendar Spread : A First Approach

One of the first "complex" strategies with options, the calendar spread, overflows interests in its management and that is why it is one of the most used strategies by market-makers.

I - Definition

The calendar spread is a strategies that implies purchasing and selling options of the same type (calls or puts), on the same underlying, having identical strikes but different maturities.

II - Vocabulary

If we call C1 a 1 year call struck at 100 on a share XYZ, and a 6 months call C2 struck at 100 concerning as well the share XYZ, as we buy the 1 year call and if we sell the 6 months call, this strategy is " traditionally " a debit, that is that we have to pay some money out to build it. That is we buy the calendar spread 6 month / 1 the year.
Conversely, we shall say that we sell the calendar 6 month / 1 the year if we sell the 1 year call C1 and we buy simultaneously the 6 months call C2.
The same thing in the case of puts.

III - On The first Profit Targets.

The first thing with the calendar spread is to notice that, other things being equal, the time value of the short term option decreases faster than that of the long term one.

We deduct from that
- When it is bought, it is interesting for the holder that the spot stays at the level near the options strike. We so prfit from time value of the option sold with the will the price stays slightly otm. the optimum is reached if the underlying ends up at 99.9 in 6 months. So the option C2 loses any value, and the buyer of the calendar would find himself with a call C1 largely financed by the sale of the first one. If nothing changed besides, the loss of option time would be totally compensated.
- It is the opposite when it is been sold, it is interesting for the seller that the spot moves away from the strike.

A long 1 year / 6 months 100 calendar Implied Volatility 30%(vol=30%, rate=5%)

Long-Calendar-Spread-100-6mois/1an-30%-30%-3D

A short 1 year / 6 months 100 calendar (vol=30%, rate=5%)

But the calendar spreads which by construction are set on two different options which differ by their respective terms is also two bets on the levels of implicit volatilities by terms.

Next :Calendar Spread
Previous : Volatility Arbitrage

Download the pricer here

Advanced Strategies - INDEX
Advanced Strategies - CHAPTER I
Advanced Strategies - CHAPTER II
Advanced Strategies - CHAPTER III
Advanced Strategies - CHAPTER IV
Advanced Strategies - CHAPTER V

Strategies-options.com