OPTIONS
Another Set Of Options
Calendar Spreads
by Joe Corona and Bill Winger
Look at the different ways you can use this strategy.
The calendar spread, also known as the time
spread or the horizontal spread, is so called because it exploits
differences in time value between options. Time value is the difference
between the option's market price and its intrinsic value. The magnitude
of the time value depends on a number of variables, including the strike
price of the option, the price of the underlying, and the implied volatility
of the option.
The calendar spread is composed of two options of the same type (both
puts or both calls), with the same strike price, but with different expiration
months. For example:
Short 1 Iti - Jan 55 call
Long 1 Iti - Mar 55 call
The objective of this spread - demonstrated later - is to profit from
the faster time-value decay of the near-month option. In order to make
sense of this technique, a clear understanding of time decay is required.
The key point to remember is this: assuming - and this is a major assumption
- all other variables are held constant as expiration approaches, the price
and time value of an option become progressively smaller.
The following spreads exploit differences in time value, and because
time value is composed of a number of factors, calendars can be tricky.
Nevertheless, with a little work, you will get the hang of them in no time.
FIGURE 1: LONG CALENDAR SPREAD. This type of strategy is used
only if you anticipate little or no movement during the lifetime of the
short near-term option.
...Continued in the October 2002 issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the October 2002
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2002, Technical Analysis, Inc.
