Using calls, the bull Calendar Spread strategy can be setup by buying long term slightly out-of-the-money calls and simultaneously writing an equal number of near month calls of the same underlying security with the same strike price.
The options trader applying this strategy is bullish over the longer term. Selling the near-month calls helps offset the cost of the longer-dated calls, but it does not make them free or guarantee that the short calls will expire worthless.
| Bull Calendar Spread Construction |
| Sell 1 Near-Term OTM Call Buy 1 Long-Term OTM Call |
Upside after the short call expires
Once the near month options expire worthless, this strategy turns into a discounted Long Call strategy and so the upside profit potential for the bull Calendar Spread becomes unlimited.
Limited Downside Risk
For a matched long calendar maintained as a hedged position, the initial debit is commonly used as the theoretical risk measure. In this example, if the short call expires worthless and the longer-dated call later also expires worthless, the loss is the original debit before costs. Assignment, dividends, financing and changes to the legs can introduce additional obligations.
Example
In June, an options trader believes that XYZ stock trading at $40 is going to rise gradually over the next four months. He enters a bull Calendar Spread by buying an OCT 45 out-of-the-money call for $200 and writing a JUL 45 out-of-the-money call for $100. The net investment required to put on the spread is a debit of $100.
In July, The stock price of XYZ goes up to $42 and the JUL 45 call expires worthless. Subsequently, the price of XYZ stock rises to $49 in October. The OCT 45 call expires in the money and is worth $400 on expiration. Since the initial debit taken to enter the trade is $100, his profit comes to $300.
Suppose the price of XYZ did not rise much and remains at or below $45 all the way until expiration of the long term call in October, the trader will lose the initial debit of $100 as both calls expire worthless.
The examples use standard U.S. equity options. Exercise style, contract size and settlement can differ for ETF, index and futures options. Matching the contract terms and managing assignment are essential.
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Commissions
The worked examples exclude commissions, fees and financing costs. Include entry, exit and any rolling costs for every leg when evaluating an actual trade.
Similar Strategies
These strategies offer related ways to express a market outlook. Their payoff, assignment exposure and response to changing volatility can differ substantially.
Neutral Calendar Spread
If the options trader is neutral on the underlying stock, he can instead implement the Neutral Calendar Spread strategy to sell the near month calls primarily to profit from time decay.
Value at the first expiration
Subtract the cost of closing or settling the short options and the original net debit from the market value of the remaining long options. Their remaining time value depends on price, implied volatility, time, rates, dividends and exercise terms. This is why a common-expiration intrinsic-value calculator cannot determine a calendar’s first-expiration result.
American-style short options can be assigned before expiration. Assignment can create a stock position, funding needs and dividend exposure. A protective long option is not automatically exercised. Closing a leg, rolling the short option or retaining the long option changes the position being evaluated.
