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.



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