How Does Horizontal Calendar Call Spread Work in Options Trading?
Horizontal Calendar Call Spread - Introduction
The Horizontal Calendar Call Spread, also known as the Call Horizontal Calendar Spread, is a neutral options strategy that profits when the underlying stock remains stagnant or within a very tight price range. It is an options trading strategy that profits using the difference in time decay between long term options and short term options and makes its maximum profit when the underlying stock remains completely stagnant. With a long term call position in place, one Horizontal Calendar Call Spread can be rolled forward for multiple months. Another advantage of the Horizontal Calendar Call Spread is that it is a debit spread, not a credit spread. This allows any options trader to put it on without any margin requirement.
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Types of Calendar Call Spreads
There are two main kinds of Calendar Call Spread; Horizontal Calendar Call Spread and Diagonal Calendar Call Spread. The Diagonal Calendar Call Spread has a higher profitability if the underlying stock is expected to move higher moderately. Therefore, if the underlying stock is expected to remain largely stagnant and may move upwards moderately, the Diagonal Call Time Spread would better maximize your profitability than the Horizontal Calendar Call Spread.
Differences Between Horizontal Calendar Call Spread and Diagonal Call Time Spread
The Horizontal Calendar Call Spread has both a lower maximum profit potential and a narrower profitable range (the stock needs to stay within a narrower price range in order to stay profitable) than the Diagonal Calendar Call Spread. However, the Horizontal Calendar Call Spread has a much higher profit if the underlying stock remained totally stagnant, closing at the same price as when the position was first put on. Despite a much narrower profitable range and maximum profit range than the Diagonal Calendar Call Spread, the Horizontal Calendar Call Spread exceeds the profitability of a Diagonal Calendar Call Spread significantly when the underlying stock remains totally stagnant. As such, if you think a stock is going to stay extremely stagnant, the Horizontal Calendar Call Spread would be your options trading strategy of choice versus the Diagonal Calendar Call Spread.
When To Use Horizontal Calendar Call Spread?
Horizontal Calendar Call Spreads could be used when you wish to profit from a stock that is expected to stay stagnant or trade within a tight price range for the short term while keeping a long term call option position in place in case of future breakouts.
How To Use Horizontal Calendar Call Spread?
In a Horizontal Calendar Call Spread, At The Money (ATM) LEAPS call options are bought and then ATM near term calls are sold against the LEAPS call options.
Buy Long Term ATM Call + Sell Short Term ATM Call
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Horizontal Calendar Call Spread Example
Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $45 Call options at $4.70. Sell To Open 10 contracts of QQQQ Jan 2007 $45 Call at $0.75. Net Debit = $4.70 - $0.75 = $3.95 |
You would notice that the Horizontal Calendar Call Spread has a lower net debit than the Diagonal Calendar Call Spread as the at the money call options written has a larger premium than the out of the money call options written in a Diagonal Calendar Call Spread.
Trading Level Required For Horizontal Calendar Call Spread
A Level 3 options trading account that allows the execution of debit spreads is needed for the Horizontal Calendar Call Spread. Read more about Options Account Trading Levels.
Profit Potential of Horizontal Calendar Call Spread :
The Horizontal Horizontal Calendar Call Spread makes its maximum profit potential when the stock closes at the strike price of the short term call options upon expiration of the short term call options.
Profit Calculation of Horizontal Calendar Call Spread:
The value of a Horizontal Calendar Call Spread during expiration of the short call options can only be arrived at using an options pricing model such as the Black-Scholes Model because the expiration value of the long term call options can only be arrived at using such a model.
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Horizontal Calendar Call Spread Example
Assuming QQQQ closes at $45 upon expiration of the short term call options. The 10 contracts of QQQQ Jan 2008 $45 Call options is now trading at $4.30. The 10 contracts of QQQQ Jan 2007 $45 Call expired worthless. Net Profit = $0.75 (total premium gained from the Jan 2007 $45 Call) - $0.40 (total premium lost on the Jan 2008 $45 call) = $0.35 x 1000 = $350. |
You would notice that the Horizontal Calendar Call Spread has a lower maximum profit than a Diagonal Calendar Call Spread.
Risk / Reward of Horizontal Calendar Call Spread:
Upside Maximum Profit: Limited
(limited to net debit paid)
Horizontal Calendar Call Spread Breakeven Calculation:
The breakeven point of a Horizontal Calendar Call Spread is the point below which the position will start to lose money if the underlying stock rises or falls strongly and can only be calculated using the Black-Scholes model.
Advantages Of Horizontal Calendar Call Spread:
:: Able to profit even if underlying asset stays stagnant.
:: Can be rolled forward for as many months as the expiration month of the long term call options.
:: No Margin Needed.
Disadvantages Of Horizontal Calendar Call Spread:
:: Profits are limited.
Alternate Actions for Horizontal Calendar Call Spreads Before Expiration :
1. If you wish to profit from a rally in the underlying asset, you could buy back the short call options before it expires and allow the LEAPS Call Options to continue its profit run.
Questions About Horizontal Time Spreads
:: "How To Erase Margin Requirement In a Time Spread?"
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