What is Calendar Spread?
Calendar Spread is an option or future market method in which two functions are placed at the same time, namely long term and short term. It involves buying a longer-term contract and selling a shorter-term contract with the same market price.
Understanding Calendar Spread
The classic calendar spread transaction entails the sales of a relatively close maturity contract (either a call or a put) and the subsequent buying of a longer-term maturity contract (call or put). Both offerings are the same kind, and the market rate is usually the same.
If there is ambiguity about the stock's movement or if there is expected volatility in the market, traders adopt the calendar spread method (vulnerability). This method comprises taking a short and long strategy on the same stock with the same share- value but separate expiration dates by purchasing a call or put options at the same time.
This technique is used by investors as a balanced or winning approach to generate increased gains from assumed price volatility, the flow of time, and stock trend uncertainties. The eventual aim of any trader who utilizes the calendar spread technique is to gain from the flow of time and price fluctuations.
The trader uses this method to take both a short and long option on certain underlying security, at the same price, but with separate maturities.
The logic behind such a tactic is that two alternatives or contracts with differing implied volatilities would move in a different manner. The behavior of the short-dated or long-dated options to duration and fluctuation rewards traders.
Practical Example
Let's say the stock of HK Limited is trading at $90.05 in mid-February. Users can select the required calendar spread:
For $0.95 ($95 for one contract), sell the March ’90 call.
For $3.20 ($320 for one contract), buy the April ’89 call.
The spread's net cost (debit) is thus (3.20 - 0.95) = $2.25 (or $225 for a single spread).
If HK Limited shares are somewhat flat until the March contracts expire, this calendar spread will pay off the most, enabling the investor to receive the extra for the option that was issued.
In Sentences
- Traders can use calendar spreads to create a deal that reduces the flow of time.