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Calendar
Spread
For
more information on Calendar Spreads please visit TerrysTips.com.
A calendar spread is when you buy an option with a longer time to
expiration (such as a LEAP)
and you sell an option with the same strike price and underlying
stock with a shorter expiration. This can be done with either
calls or puts, but you have to either buy and sell puts or calls,
you cannot buy puts and sell calls, or visa versa. The basic
idea of a calendar spread is to profit on the different rates of
decay on the two options: The long-term option you buying will
decay, or decline in value, at a rate slower than a short-term
option, all else being equal.
Calendar spreads are also referred to as horizontal spreads because
the spread is based on time. They're also called a vertical
spread because option quotes are listed top to bottom, and the
spread involves buying near the bottom and selling near the top.
Example:
QLogic 12-month $50 calls sell for $5.30, while 1-month $50 calls
sell for $.85. If the stock stays flat, the 1-month calls will
decay $.85 in 30 days, while the 12-month calls will decay $.44
($5.30 / 12 months). Thus, if you buy the 12-month calls and sell the 1-month
calls, you make $.44 per share.
The above example assumes that the stock stays flat, which is rarely
ever the case in the real world. If the stock fluctuates
wildly in price, you are likely to lose money on the spread.
That is why the Calendar Spread is risky. It is best to do
this spread on stocks you think will stay relatively flat in price.
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