|
Friday September 03, 2010 |
Advanced Strategies for Options -
Horizontal Spreads - Bullish Calendar Spread
For
aggressive investors a bullish calendar spread may be more
suitable. In a
bullish calendar spread one sells the near term call and buys a
longer term call but he does so when the underlying stock is well
below the strike price of the calls. The advantage of doing this is both calls are very close in
price thus the initial debit is extremely small.
This
type of position can be very attractive because of the low dollar
investment and large potential profit but two criteria must be
fulfilled to generate maximum profits.
As
with any spread the first criterion is that the sold or near month
call expires worthless. There is a reasonably good chance this
will occur because of the short time frame to expiration and the
fact that the stock is initially well below the strike price. If the stock falls or rises only modestly the first
criterion will be met.
The
second criterion is a different kettle of fish. Unlike the neutral calendar spread when it is in the best
interest of the investor to liquidate the long call position when
short call position expires, the bullish calendar spread involves
holding the long call position. The investor is essentially selling the near month call to
offset the cost of the distance month call. If the stock rises substantially there is tremendous profit
potential because should the first criterion be met the effective cost the
long call position is small.
When
using bullish calendar spreads investors should be careful to
ensure the underlying security has sufficient volatility. As mentioned above for this strategy to really be effective
the stock must rise substantially. It is also important that investors not use strike prices
too far above the current underlying stock price. Once again the position only generates significant gains if
the long call position gets into the money. It’s important to make this possibility realistic.
Megan
believes in the seasonality of Internet stocks. For several years these issues have traded sideways to
lower during the summer months only to rise substantially into the
holiday season. With
this in mind Megan decides to establish a bullish calendar spread
for her favorite Internet retailer, Amazon.com (AMZN). With Amazon trading at 70 in May Megan sells one contract
of the AMZN July 80 call for $12 and buys one contract of the AMZN
December 80 call for $14 for a net debit of $2 per contract or
$200.
If
AMZN rises substantially prior to the expiration of the short
calls (July) the spread will effectively be in-the-money and
losses may occur. The
deeper in-the-money the worse it is for Megan but her losses are
limited to the net debit of $200.
For
the purpose of the following example we will assume that the short
call expires worthless thereby reducing Megan’s cost of the long
call positions by $12 per contract.
|
AMZN
Share Price at Expiration
|
July
80 call price
|
Profit
for July 80 call calls
|
December
80 call price
|
Profit
for December 80 calls
|
Total
Profit
|
|
70
|
$0
|
$1,200
|
$0
|
($1,400)
|
($200)
|
|
75
|
$0
|
$1,200
|
$0
|
($1,400)
|
($200)
|
|
80
|
$0
|
$1,200
|
$0
|
($1,400)
|
($200)
|
|
85
|
$0
|
$1,200
|
$5
|
($900)
|
$300
|
|
90
|
$0
|
$1,200
|
$10
|
($400)
|
$800
|
|
95
|
$0
|
$1,200
|
$15
|
$100
|
$1,300
|
|
100
|
$0
|
$1,200
|
$20
|
$600
|
$1,800
|
As
we can see Megan’s losses are limited to her initial debit of
$200. After AMZN’s
stock price moves beyond the $80 strike price the big profits
begin. In fact, if
AMZN rises to $100 by the December expiration Megan makes a profit
of $1,800 on her modest $200 investment, a return of 900%.
Summary:
1. Bullish calendar spreads can yield huge profits if
the near term call expires worthless and the underlying stock
price rises substantially after the near month expiration.
2.
Risk
is limited to the net debit.
neutral
calendar spread 
delta neutral calendar spread
|
Home > Education > Using Options > Advanced Strategies >
Horizontal Spreads > Bullish
Calendar Spread
