Quote from Maverick74:
OK, so let's walk through this. Say you put on a calendar spread in Aug/Sept at the 100 strike in XYZ which is trading at a 100. You sell the spread for 2.00. You want the broker to ask you how much in margin? Right now you will put up 2k for this trade to sell the spread and $200 to buy the spread. Let's be nice and say this broker only asks for $400. Say you put the spread on 10 times for 4k in margin. Say some news comes out that on Sept 10th a critical verdict will come out on a court case that will decide if this company will stay in business or not. So the back month 100 strike call and put both shot up in value from say 4.00 to 40.00. The front month call and put didn't change, let's say it's 2.00. Your spread you sold for 2.00 is now 38 pts against you or 38k. Let's say you had 45k in your account, plenty of cash for the 4k in margin your broker was asking for. But now your equity is down to 7k. What is your risk? You say you are hedged? Hedged against what? The stock is not going to move until sept 10th, then it will either explode up or possibly go to zero. Your long call "your hedge" expires on say Aug 21st. You say no problem mr. broker, I'll buy the stock. You will? You will buy 1k shares at $100 per share? That's 50k in margin, you only have 7k in your account. And if for some reason you did buy the 1k shares of stock do you know what your risk is? It's not to the upside, it's to the downside. If the stock goes to zero, OK, you make back the loss on the short Sept call as they go out worthless. But the long stock at 100 goes to zero and you are out 100k. You made back 40k from the short calls leaving you with a 60k loss. Your account only had 45k in it to start with.
This is why the margin is not going to be $200 as is the case with the long spread or even $400. Even with the margin they are asking of 20% or 20k, it's not even enough. That's why I said initially the margin should be even higher then the standard 20%. And what makes this worse is, most guys who do these trades are not putting them on when vol is cheap, they are putting them on precisely to try to exploit that back month vol which is usually high for a reason! The market is telling you it's going to make a large move during that time period. Not when you have your long call on. So either you get forced into a margin call when the spread blows out to 40 pts or you say F*ck it, I'll take my chances and exercise the stock and gamble on a non event news item. Either way, short calendar spreads are NOT hedged trades. Not even remotely close to hedged. In fact, you are specifically making a binary trade on an explosive outcome in which you have no control over and no ability to do anything after such event occurs. Hopefully, I've explained to you the dangers of this trade.
