would have been if a short-term, less expensive August 60 call were the
long leg of this spread.
Rolling the Spread
The July–December spread is different from short-term spreads, however.
When the Julys expire, the August options will have 29 days until
expiration. If volatility is still the same, XYZ is still at $60, and the trader’s
forecast is still neutral, the 29-day August 60 calls can be sold for 1.45. The
trader can either wait until the Monday after July expiration and then sell
the August 60s, or when the Julys are offered at 0.05 or 0.10, he can buy the
Julys and sell the Augusts as a spread. In either case, it is called rolling the
spread. When the August expires, he can sell the Septembers, and so on.
The goal is to get a credit month after month. At some point, the
aggregate credit from the call sales each month is greater than the price
initially paid for the long leg of the spread, thus eliminating the original net
debit. Exhibit 11.6 shows how the monthly credits from selling the one-
month calls aggregate over time.
EXHIBIT 11.6 A “free” call.
After July has expired, 1.45 of premium is earned. After August
expiration, the aggregate increases to 2.90. When the September calls,
which have 36 days until expiration, are sold, another 1.60 is added to the
total premium collected. Over three months—assuming the stock price,
volatility, and the other inputs don’t change—this trader collects a total of
4.50. That’s 0.50 more than the price originally paid for the December 60
call leg of the spread.
At this point, he effectively owns the December call for free. Of course,
this call isn’t really free; it’s earned. It’s paid for with risk and maybe a few
sleepless nights. At this point, even if the stock and, consequently, the