The In-or-Out Crowd
Pete could just as well have traded the Aug–Sep 50 put calendar in this
situation. If he’d been bearish, he could have traded either the Aug–Sep 45
call spread or the Aug–Sep 45 put spread. Whether bullish or bearish, as
mentioned earlier, the call calendar and the put calendar both function about
the same. When deciding which to use, the important consideration is that
one of them will be in-the-money and the other will be OTM. Whether you
have an ITM spread or an OTM spread has potential implications for the
success of the trade.
The bid-ask spreads tend to be wider for higher-delta, ITM options.
Because of this, it can be more expensive to enter into an ITM calendar.
Why? Trading options with wider markets requires conceding more edge.
Take the following options series:
By buying the May 50 calls at 3.20, a trader gives up 0.10 of theoretical
edge (3.20 is 0.10 higher than the theoretical value). Buying the put at 1.00
means buying only 0.05 over theoretical.
Because a calendar is a two-legged spread, the double edge given up by
trading the wider markets of two in-the-money options can make the out-of-
the-money spread a more attractive trade. The issue of wider markets is
compounded when rolling the spread. Giving up a nickel or a dime each
month can add up, especially on nominally low-priced spreads. It can cut
into a high percentage of profits.
Early assignment can complicate ITM calendars made up of American
options, as dividends and interest can come into play. The short leg of the
spread could get assigned before the expiration date as traders exercise calls
to capture the dividend. Short ITM puts may get assigned early because of
interest.
Although assignment is an undesirable outcome for most calendar spread
traders, getting assigned on the short leg of the calendar spread may not
necessarily create a significantly different trade. If a long put calendar, for