spreads are known as horizontal spreads, and the Calendar Call is a variation
of a Covered Call, where you substitute the long stock with a long-term long
call option instead. This has the effect of radically reducing the investment,
thereby increasing the initial yield. However, this initial yield is not
necessarily reflective of the maximum yield at the expiration of the short-term
short call. The maximum yield will depend on both the stock price and the
residual value of the long unexpired call.
problem with a Calendar Call is in the very essence of the shape of the risk
profile (see the following). What we would like to do is create something
similar to a Covered Call, but with a better yield and without the expense. The
Calendar Call certainly requires less investment; however, the shape is
different. If the stock rises too far too soon, then the Calendar Call can
become loss-making. So even though you got the direction of the trade right,
you could still lose money!
happens because the long call, being near the money, only moves at around half
the speed as the underlying stock as the stock price rises. This means that in
the event of exercise, if the stock has risen by, say, $10.00 from $30.00, and
your option has only risen by $5.00, you may be exercised on the short call;
therefore you buy the stock at $40.00 and sell it at $30.00 (if that was the
strike), yet your long call has only risen by $5.00, giving you a $5.00 loss.
If you only received $2.00 for the short call, you are looking at a $3.00 loss
on the trade.
options share the same strike, so if the stock rises above the strike, your
short call will be exercised. You will then have to sell the long call
(hopefully for a profit), use the proceeds to buy the stock at the market
price, and then sell it back at the strike price. Therefore, the best thing
that can happen is that the stock is at the strike price at the first
expiration. This will enable you to write another call for the following month
if you like.
this strategy when the environment is neutral to bearish and you want to generate
income on your long term position by selling calls and receiving the premium.
is trading at $65 on May 12, 2011. Normally, it has 30% volatility.
January 2013 65 strike calls at $12.50.
June 2011 65 strike calls at $2.70.
benefit of this trade is the ability to generate some income on your long term
position by selling calls to receive the premium.
risk is limited to the net debit of the calls you bought minus the calls you
sold. The reward is limited to the remaining call value when the stock is at
strike at expiration, minus the net debit.
call value when short call expires (when stock is at strike price) net debit.
net debit paid.
on the value of the long call when the short call expires.
Of Time Decay
in that it decays the value of the long call. However, it helps income by
eroding the short call faster.
the short call expire worthless and keep the entire premium if the stock stays
under the strike, but above the higher stop loss. If you wish, you can write
another call for the following month.
the long or reverse the position if the stock falls under the lower stop loss.
you are exercised, sell the long call, buy the stock at market price, deliver
it at the strike price, and profit from the short option premium you received
as well as the long option premium. Do not exercise the long option so as not
to lose its time value.