Calendar Spreads Using Options

January 6, 2010

We know that the bane of most option purchasers is time erosion – options tend to waste away, despite our hard work in trying to determine market direction and being correct with our market direction.

Typically, one must pick the correct direction of the market to make profit on a calendar spread.  As discussed in other articles on this site, we don’t like to purchase options as an outright investment.   Therefore, we purchase and sell options as a spread.  A calendar spread involves buying an option with more time premium while selling an option of the same strike price, but the option that is sold has less time premium.

For example, an investor that is bullish Corn futures could purchase a May 450 Corn Call option and sell a March 450 Call option.  The objective is two-fold: 1) the investor prefers Corn Futures to trade higher; 2) the March option that is sold should lose its premium at a faster rate than the option that is purchased.

An additional advantage to trading options as a spread (rather than trading outright futures or selling options short) is that the initial margin on spread positions is usually lower than the margin on a futures or option selling strategy.

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