In the money Calendar Spread

J

jdoucet

I am wanting some feedback on a calendar spread. Let's say that the underlying is at $50. If I bought a calendar spread like this:

Short OCT $47.50Call
Long NOV $47.50Call

Net Debit of: .30

Does anyone see anything wrong with that? I mean the stock has been holding steady between $49.00 and $50.15. Is it advisable to put this trade on or should I walk away? I appreciate any feedback I can get. Thanks guys.
 
PUT and CALL calendars are synthetically equivalent i.e. an ITM CALL calendar is an OTM PUT calendar where the same strike is used.

The difference in pricing is due to cost of carry.

Your CALL calendar will have a short ITM CALL in the front month which might be at risk of early assignment etc. If that is a concern for you, you may wish to look at the equivalent PUT calendar.

Calendars are essentially long VEGA strategies. You are buying volatility (back month). Is that consistent with your forecast?

If you're using it as a direction-neutral strategy for the underlying to expiration without a forecast for volatility in the interim etc. you may want to look at using a fly or condor instead though these are more legs and are short VEGA (mild).

2 cents.

MoMoney.
 
The term "synthetic equivalent" is not registering with me. What exactly does that mean? I see that term used quite often.
 
So in a scenario like I have, if I am assigned would that be a bad thing since I have a long option at the same strike? would I be losing money?
 
Quote from jdoucet:

So in a scenario like I have, if I am assigned would that be a bad thing since I have a long option at the same strike? would I be losing money?
More...

Your risk on the call calendar is a drop in share price, decay and potential vega loss... before you can sell the long call. FWIW, your calendar is likely dead if assignment is an issue.
 
I see. Thanks for your help. My next question is how likely is it that I would be assigned early on something like that? The reason I'm asking is because I've never sold an option that was already in the money. I have sold OTM options that end up in the money though. Would I be assigned if there is a lot of time value left on the option, and if so, couldn't I just re-enter the spread again if there is a lot of time before expiry?
 
Quote from jdoucet:

I see. Thanks for your help. My next question is how likely is it that I would be assigned early on something like that? The reason I'm asking is because I've never sold an option that was already in the money. I have sold OTM options that end up in the money though. Would I be assigned if there is a lot of time value left on the option, and if so, couldn't I just re-enter the spread again if there is a lot of time before expiry?
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If the extrinsic value is < the carry on holding the call. Practically-speaking, it's not much of an issue if there is any time premium left in the call.
 
A calendar spread profits from the passage of time and/or an increase in implied volatility.

Since both legs have the same strike, if ITM, they will have the same intrinsic value and the extrinsic or time value of the near term leg (Oct) will be less than the far term (Nov). That's where your profit potential comes from.

A calendar's maximum value occurs at the strike because that is where the time premium is the highest. Your call calendar is bearish because it is ITM by 2-1/2 pts. It must drop to realize its maximum gain.

I would suggest that you use the 47-1/2 puts instead so that you diminish the chance of early exercise.

And if you are neutral, go with the 50 calendar.
 
Quote from jdoucet:

"So in a scenario like I have, if I am assigned would that be a bad thing since I have a long option at the same strike? would I be losing money?"

As long as you did not botch closing the position, you would not be losing money. Early assignment would result in short stock protected by a long call with the same strike as the cost of the stock (ignoring the initial 30 ct debit). You could actually make some decent money to the downside.


Quote from riskarb:

"Your risk on the call calendar is a drop in share price, decay and potential vega loss... before you can sell the long call. FWIW, your calendar is likely dead if assignment is an issue."

I disagree. The calendar benefits from time decay. A drop in share price to 47.5 expands the calendar's value.

If there is early assignment on the short call, he ends up with a synthetic put (short stock bot at 47.5 protected by a long Nov 47.5 call). If the stock drops, he makes out like a bandit. If it rises, he can exercise his long call to buy the stock to cover (or close both legs if the call has time premium remaining). Only a botched leg out will hurt him.

Either way, to the upside, he loses no more than the initial debit of 30 cts.
 
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