Bull Calendar Spread
Bull Calendar Spread - Overview
A Bull Calendar Spread, is an options strategy that involves purchasing options with different expirations. This strategy is also known as a time spread or horizontal spread and is a direction neutral, medium risk, and unlimited reward strategy. Buying a calendar spread involves buying a longer term LEAP call and selling a shorter dated call, resulting in a net debit transaction. The crux of this strategy revolves around the idea that the theta on the shorter term option will increase rapidly as expiration approaches which causes the shorter term option to lose its time value much faster than a longer dated one. Traders who create a bull calendar spread are expecting the underlying security to remain relatively neutral until the expiration of the short call. These traders are usually longer term bulls who are looking to essentially lower the cost of their longer term option.
How Do I Select the Options to Use in a Bull Calendar Spread?
The LEAP options should be purchased in the money while the shorter dated options can be ATM or even OTM. The options are structured this way for risk mitigation purposes. If the underlying starts to run rapidly, we want to make sure that our delta spread between the two options is positive. This basically means that the LEAP will increase faster in value than a shorter dated option due to the fact that it is delta positive.
You can almost view a bull calendar spread as a covered call in a sense. The short call option provides as a short term hedging solution to the risk of the longer term option and allows you to lower your cost on the long option.
Bull Calendar Spread Risk Characteristics
This strategy is a limited risk, limited reward strategy up until the expiration of the short option. The most amount of profit will be made when the underlying closes at the strike price of the short call option, this will render it worthless. Once the shorter dated option expires, the profit potential becomes unlimited. Essentially, you are long a call option.
Risk & Profit Potential
Transaction Cost = Long Call Premium - Short Call Premium
The risk in this trade is then limited to the actual transaction cost.