You Can Spread Time

2/24/2014

Time is a huge factor in making up the price of the option. Options are a decaying asset by their nature but that doesn't mean all options decay at the same rate. As expiration approaches time decay tends to accelerate. Which gives some great opportunities for trading time. One of my favorite and most versatile option strategies is the time, or calender, spread. Let's look first at the horizontal calender spread. So called because it involves the same exercise price but different expiration months.

A horizontal calender spread is a great way to play a move that you think is coming down the line but not just yet. Let's say you think the market will trade unchanged to slightly higher in March and then have a drop in May. Using Friday's prices you could sell the March 180 put at 1.75 and buy the May 180 put at 3.35. If the March put expires worthless you own the May put at an effective price of 1.50, or less than half the price of where it's trading now.

Another low risk directional way to use calender spreads is taking advantage of this truth :
A Calender Spread is Widest at the Strike

Look at it logically. Take a hypothetical stock trading at 100 . The first month - second month 25 call calender has both options so deep in the money that there will be virtually no difference between them. The first month - second month 175 call spread has both options so far out of the money that there will be virtually no difference between them. Therefore, logic shows that the time spread is widest at the strike. Which means if the stock is, say, 80 and I think it will drift higher to 100 then I want to buy the 100 calender spread because it will widen as the stock approaches the strike. The same holds true if the stock is 120 and I think it will drift lower to 100 then I want to buy the spread.

However, if the stock is exactly at 100 and I think one thing is for certain, up or down, the stock will move away from 100, then I want to sell the spread (ie, buy front month sell later month) because the spread will narrow in price as the stock moves away from the strike. It's a low risk and moderate reward strategy.

So, you see... Time is Spreadable!

By: Randall Liss, The Liss Report