30 lines
2.0 KiB
Plaintext
30 lines
2.0 KiB
Plaintext
Buying the Calendar
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The calendar spread and all its variations are commonly associated with
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income-generating spreads. Using calendar spreads as income generators is
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popular among retail and professional traders alike. The process involves
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buying a longer-term at-the-money option and selling a shorter-term at-the-
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money (ATM) option. The options must be either both calls or both puts.
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Because this transaction results in a net debit—the longer-term option being
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purchased has a higher premium than the shorter-term option being sold—
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this is referred to as buying the calendar.
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The main intent of buying a calendar spread for income is to profit from
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the positive net theta of the position. Because the shorter-term ATM option
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decays at a faster rate than the longer-term ATM option, the net theta is
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positive. As for most income spreads, the ideal outcome occurs when the
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underlying is at the short strike (in this case, shared strike) when the
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shorter-term option expires. At this strike price, the long option has its
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highest value, while the short option expires without the trader’s getting
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assigned. As long as the underlying remains close to the strike price, the
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value of the spread rises as time passes, because the short option decreases
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in value faster than the long option.
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For example, a trader, Richard, watches Bed Bath & Beyond Inc. (BBBY)
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on a regular basis. Richard believes that Bed Bath & Beyond will trade in a
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range around $57.50 a share (where it is trading now) over the next month.
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Richard buys the January–February 57.50 call calendar for 0.80. Assuming
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January has 25 days until expiration and February has 53 days, Richard will
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execute the following trade:
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Richard’s best-case scenario occurs when the January calls expire at
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expiration and the February calls retain much of their value.
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If Richard created an at-expiration P&(L) diagram for his position, he’d
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have trouble because of the staggered expiration months. A general
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representation would look something like Exhibit 11.1 . |