Chapter 13: Reverse Spreads 231 
calendar spread makes the most money if the stock is right at the strike price at expi­
ration, and it loses money if the stock rises or falls too far. 
As with any spread involving options expiring in differing months, it is common 
practice to look at the profitability of the position at or before the near-term expira­
tion. An example will show how this strategy can profit. 
Example: Suppose the current month is April and that XYZ is trading at 80. 
Furthermore, suppose that XYZ's options are quite expensive, and one believes the 
underlying stock will be volatile. A reverse calendar spread would be a way to profit 
from these assumptions. The following prices exist: 
XYZ December 80 call: 12 
XYZ July 80 call: 7 
A reverse calendar spread is established by selling the December 80 call for 12 
points, and buying the July 80 call for 7, a net credit of 5 points for the spread. 
If, later, XYZ falls dramatically, both call options will be nearly worthless and the 
spread could be bought back for a price well below 5. For example, if XYZ were to 
fall to 50 in a month or so, the July 80 call would be nearly worthless and the 
December 80 call could be bought back for about a point. Thus, the spread would 
have shrunk from its initial price of 5 to a price of about 1, a profit of 4 points. 
The other way to make money would be for implied volatility to decrease. 
Suppose implied volatility dropped after a month had passed. Then the spread might 
be worth something like 4 points - an unrealized profit of about 1 point, since it was 
sold for a price of 5 initially. 
The profit graph in Figure 13-1 shows the profitability of the reverse calendar. 
There are two lines on the graph, both of which depict the results at the expiration 
of the near-term option (the July 80 call in the above example). The lower line shows 
where profits and losses would occur if implied volatility remained unchanged. You 
can see that the position could profit if XYZ were to rise above 98 or fall below 70. 
In addition, the higher curve on the graph shows where profits would lie if implied 
volatility fell prior to expiration of the near-term options. In that case, additional prof­
its would accrue, as depicted on the graph. 
So there are two ways to make money with this strategy, and it is therefore best 
to establish it when implied volatility is high and the underlying has a tendency to be 
volatile. 
The problem with this spread, for stock and index option traders, is that the call 
that is sold is considered to be naked. This is preposterous, of course, since the short­
term call is a perfectly valid hedge until it expires. Yet the margin requirements 
remain onerous. When they were overhauled recently, this glaring inefficiency was