Wednesday, 20 January 2016

CALENDAR/TIME SPREADS

another strategy used in options is calendar, or time, spreads. In a calendar spread, you establish your position by entering a long and short position at the same time on the same underlying asset, but with different delivery months.
The point of this strategy is, time decay happens much more quickly the closer we get to expiration. The theory is that when you short the front-month option, you’ve got that quickly-evaporating time premium working with you, faster than the decay in the further out option that you bought. “Just like the call and put spreads, you’re paying a debit for the spread and the further out you go in time; the bigger that debit’s going to be. You’re looking for a stock at expiration to be at the strike that you have put this spread on”.
The further out you go in time, the more volatility you buy in the spread. if you pick an out-of-the money strike and the maximum spread, for this to work to your benefit the underlying has to go up to that strike for this spread to be at its widest point of expiration. “If you pick the at-the-money strike, you want the [underlying] to hang out around that strike, and if you pick the in-the-money, you want the [underlying] to go down. You are long volatility in this spread. You want to be cognizant of volatility levels”.

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