Max @ Risk for Calander Spread

[quantdropout]

I have read many articles suggesting that the max at risk when you enter a calendar spread is the initial debit.

Prior to expiration, assuming the IV goes through the roof in the near term short position, while IV further out long remains constant, is it possible to lose more that initial debit?

 

[Profitaker]

Quote from quantdropout:

I have read many articles suggesting that the max at risk when you enter a calendar spread is the initial debit.

At expiry, yes.

Quote from quantdropout:

Prior to expiration, assuming the IV goes through the roof in the near term short position, while IV further out long remains constant, is it possible to lose more that initial debit?

You want IV to rise across all months, as you have more Vega in the far dated than you do in the near dated - meaning the spread will profit from a rise in IV across both months.

But in scenario you've given yes, you could lose more than your initial credit if you close out the spread. But an IV spike wouldn't normally be confined to the front month. Unless of course anyone knows different....

 

[quantdropout]

Thank you for your insight Profitaker

Quote from Profitaker:
But an IV spike wouldn't normally be confined to the front month. Unless of course anyone knows different....

I'm seeing IV increase the day or so before earnings release in the front month that is not necessarily correlated with further out month. I have been in the money, so my profit has shrunk, i am just wondering if i was in a loss position (which happens all too often) could such a spike cause me to lose more that my initial Debit (not credit) amount (not familiar enough with credit spread- the distinction may not matter).

 

[Profitaker]

Quote from quantdropout:

i am just wondering if i was in a loss position (which happens all too often) could such a spike cause me to lose more that my initial Debit

Having thought about it some more, if IV spiked in the front month such to cause a spread loss which exceeded your initial debit, then what you are actually suggesting is that the front month option (short) must be worth more than the far month option (long). If that were to happen then there would be an arb by executing another calender, this time for a credit - at front month expiry you will close the far and keep the initial credit, regardless.

Quote from quantdropout:

Prior to expiration, assuming the IV goes through the roof in the near term short position, while IV further out long remains constant, is it possible to lose more that initial debit?

So, I would say a categoric No to your question.

 

[Profitaker]

But just wait for confirmation from others before you go launching into multiple Calenders...

 

[El OchoCinco]

I cannot see how you can lose more than your initial debit on a vanilla long calendar. If you paid $1.80 debit for the spread and close the spread as opposed to legging out, it can only be worth $0.00 at worst. You could not sell the spread to close for less than $0.00 to have a loss greater than $1.80.

The only way you can lose more than your debit is if you try to get cute and leg out at different times and some wild market swings kill you.

 

[MTE]

On call calendars the maximum potential loss is the intial debit plus the dividend, if you're unlucky enough to get assigned on the short call going ex-div.

Coach is right, the only way to lose more is to get creative and leg out.

 

[jhickman]

So it seems that the potential maximum loss is more than your initial debit - it is your initial debit PLUS any dividends if you are assigned on your short call.
Cheerio
ra1

 

[nlslax]

Hey Guys,
Tell me what the downside is here.

The Q's were ~$42 earlier today. The Feb/Mar 40 Call spread could have been bot for $.30
FYI - The OOM $44 spread could have been bot for $.30 also.

My thinking is that if the spread is in the money just prior to Feb exp the time value of the Mar call will be higher than the time value of the Feb call, and greater than the initial cost of the spread ($.30). Close the spread before exp for a profit.

What is the effect of early assignment?

If the spread is OOM at exp, let Feb expire and sell the Mar.

I would be interested in hearing how others manage these types of spreads.

Thanks for the input. Please be gentle.

 

[MTE]

Quote from nlslax:

Hey Guys,
Tell me what the downside is here.

The Q's were ~$42 earlier today. The Feb/Mar 40 Call spread could have been bot for $.30
FYI - The OOM $44 spread could have been bot for $.30 also.

My thinking is that if the spread is in the money just prior to Feb exp the time value of the Mar call will be higher than the time value of the Feb call, and greater than the initial cost of the spread ($.30). Close the spread before exp for a profit.

What is the effect of early assignment?

If the spread is OOM at exp, let Feb expire and sell the Mar.

I would be interested in hearing how others manage these types of spreads.

Thanks for the input. Please be gentle.

Rather than trying to guess what the spread will be worth at Feb expiry if QQQQ is @ ...., use a pricing model to find the exact value (although, you can't use the word "exact" in the same sentence with calendar spread).

Calendar spread achieves maximum profit if the stock is exactly at the strike at expiry no matter whether the spread was ATM, OTM or ITM when you bought it.