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Short Horizontal Calendar Put Spread - Introduction
The Short Horizontal Calendar Put Spread, also known as the Short Put Horizontal Calendar Spread or Horizontal Short Calendar Put Spread, is a volatile options trading strategy that profits when the underlying stock breaks out to upside or downside. As a form of short calendar spread, the Short Horizontal Calendar Put Spread has the unique characteristic of having a much higher maximum potential profit than maximum potential loss, putting reward/risk ratio in your favor. Most other volatile options strategies have a larger maximum potential loss than maximum potential gain. As a credit spread, margin will also be required. This tutorial shall explain what the Short Horizontal Calendar Put Spread is, how to use it and what its advantages and disadvantages are.
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Types of Short Calendar Call Spreads
There are two main kinds of Short Calendar Put Spread; Short Horizontal Calendar Put Spread and Short Diagonal Calendar Put Spread.
The Short Diagonal Calendar Put Spread has a higher profitability than the Short Horizontal Calendar Put Spread if the underlying stock is expected to breakout to upside more than it will breakout to downside. The Short Horizontal Calendar Put Spread would have an equal profitability no matter which direction the stock breaks. As such, if the direction of breakout of the stock is uncertain, the Short Horizontal Calendar Put Spread would be a better choice than the Short Diagonal Calendar Put Spread.
Differences Between Short Horizontal Calendar Put Spread and Short Diagonal Call Time Spread
The Short Horizontal Calendar Put Spread has both a lower maximum profit potential but narrower breakeven points than the Short Diagonal Calendar Call Spread. The Short Horizontal Calendar Put Spread also has a much higher profit if the underlying stock break out downwards. This difference is due to the fact that out of the money put options are bought in the Short Diagonal Calendar Put Spread while at the money put options are bought in the short horizontal calendar put spread. Because out of the money put options with lower extrinsic value than at the money put options are bought in a Short Diagonal Calendar Put Spread, it has a higher maximum profit potential than the Short Horizontal Calendar Put Spread but only when the stock breaks out upwards. Because at the money put options are bought instead of out of the money put options, a narrower breakeven point results due to greater rise in value of the put options when the stock breakout to downside.
When To Use Short Horizontal Calendar Put Spread?
Short Horizontal Calendar Put Spreads could be used when you wish to profit from a stock that has an equal chance of breaking out to upside or downside.
How To Use Short Horizontal Calendar Put Spread?
In a Short Horizontal Calendar Put Spread, At The Money (ATM) LEAPS put options are written and ATM near term puts are bought.
Buy Short Term ATM Put + Sell Long Term ATM Put
Short Horizontal Calendar Put Spread Example
Assuming QQQQ trading at $45 now. Sell To Open 10 contracts of QQQQ Jan 2008 $45 put options at $4.70.
Buy To Open 10 contracts of QQQQ Jan 2007 $45 put at $0.75.
Net Credit = $4.70 - $0.75 = $3.95
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Profit Potential of Short Horizontal Calendar Put Spread :
The Horizontal Short Horizontal Calendar Put Spread makes its maximum profit potential when the underlying stock stages a breakout to either upside or downside that is significant enough to wear out all of the extrinsic value on the long term short put options due to options moneyness.
Profit Calculation of Short Horizontal Calendar Put Spread:
Maximum profit = net credit
Maximum loss occurs when the underlying stock remains stagnant. When that happens, the short term at the money put options expires worthless and the long term at the money put options do not reduce enough value due to time decay to offset the loss on the short term put options. Specific value can only be obtained using the Black-Scholes Model.
Short Horizontal Calendar Put Spread Example
Assuming QQQQ closes at $55 upon expiration of the short term call options.
Both long and short term $45 strike price call options are trading at $10.00 with no extrinsic value left.
Profit = net credit = $3.95
Assuming QQQQ remained stagnant and closed at $45 upon expiration of the short term call options.
The 10 contracts of QQQQ Jan 2007 $45 Call expired worthless.
The 10 contracts of QQQQ Jan 2008 $45 Call are trading at $4.30.
Net Loss = $0.75 - ($4.70 - $4.30) = $0.35
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Risk / Reward of Short Horizontal Calendar Put Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Short Horizontal Calendar Put Spread Breakeven Calculation:
The breakeven point of a Short Horizontal Calendar Put Spread can only be calculated using the Black-Scholes model.
Advantages Of Short Horizontal Calendar Put Spread:
Greater maximum potential gain than maximum potential loss
Profit from stocks expecting to breakout in either direction
Narrower breakeven points than the Short Diagonal Calendar Put Spread
Lower maximum loss than Short Diagonal Calendar Put Spread
Disadvantages Of Short Horizontal Calendar Put Spread:
Lower maximum potential gain than the Short Diagonal Calendar Put Spread
Margin is needed
Alternate Actions for Short Horizontal Calendar Put Spreads Before Expiration :
1. The moment the extrinsic value of the long and short term options are almost completely eroded due to a significant breakout, the position should be closed and profit taken. There is no need to hold til expiration because the engine that makes this options trading strategy work is the breakout, not time decay.
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