Chapter 9: Calendar Spreads 195 
on the position. Another choice is to leave the spread alone until the near-term call 
expires and then to hope for a partial recovery from the stock in order to be able to 
recover some value from the long side of the spread. Such a holding action is often 
better than the immediate close-out, because the expense of buying back the short 
call can be quite large percentagewise. A riskier downside defensive action is to sell 
out the long call if the stock begins to break down heavily. In this way, the spreader 
recovers something from the long side of his spread immediately, and then looks for 
the stock to remain depressed so that the short side of the spread will expire worth­
less. This action requires that one have enough collateral available to margin the 
resulting naked call, often an amount substantially in excess of the original debit paid 
for the spread. Moreover, if the underlying stock should reverse direction and rally 
back to or above the striking price, the short side of the spread is naked and could 
produce substantial losses. The risk assumed by such a follow-up violates the initial 
neutral premise of the spread, and should therefore be avoided. Of these three types 
of downside defensive action, the easiest and rrwst conservative one is to do nothing 
at all, letting the short call expire worthless and then hoping for a recovery by the 
underlying stock. If this tack is taken, the risk remains fixed at the original debit paid 
for the spread, and occasionally a rally may produce large profits on the long call. 
Although this rally is a nonfrequent event, it generally costs the spreader very little 
to allow himself the opportunity to take advantage of such a rally if it should occur. 
In fact, the strategist can employ a slight modification of this sort of action, even 
if the spread is not at a large loss. If the underlying stock is moderately below the 
striking price at near-term expiration, the short option will expire worthless and the 
spreader will be left holding the long option. He could sell the long side immediate­
ly and perhaps take a small gain or loss. However, it is often a reasonable strategy to 
sell out a portion of the long side - recovering all or a substantial portion of the ini­
tial investment - and hold the remainder. If the stock rises, the remaining long posi­
tion may appreciate substantially. Although this sort of action deviates from the true 
nature of the time spread, it is not overly risky. 
An early breakout to the upside by the underlying stock is generally handled in 
much the same way as a downside breakout. Doing nothing is often the best course 
of action. If the underlying stock rallies shortly after the spread is established, the 
spread will shrink by a small amount, but not substantially, because both options will 
hold premium in a rally. If the spreader were to rush in to close the position, he 
would be paying commissions on two rather expensive options. He will usually do 
better to wait and give himself as much of a chance for a reversal as possible. In fact, 
even at near-term expiration, there will normally be some time premium left in the 
long option so that the maximum loss would not have to be realized. A highly risk­
oriented upside defensive action is to cover the short call on a technical breakout and