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Bull Calendar Spread Introduction
The Bull Calendar Spread, also called a Calendar Call Spread, is a bullish strategy that profits in pretty much the same way a Covered Call does;
When the stock stays stagnant or goes up.
Another way of looking at the Bull Calendar Spread is that it is a leveraged Covered Call that replaces the underlying asset with its LEAP so that more
short positions can be written. A Bull Calendar Spread profits primarily from the difference in rate of premium decay between the near term short options and the long term LEAPs.
This is possible because near term option premiums decay faster than long term option premiums.
Because you need to buy LEAPs which are more expensive than the short term options that you will write, this strategy results in a net debit and is therefore a form of Debit Spread.
As you are buying options of different expiration months and different strike prices in this strategy, it is also classified as a Diagonal Spread or Time Spread.
(These classifications are only for a deeper understanding of the kinds of option spread strategies and is not necessary for the execution of these strategies.)
When To Use Bull Calendar Spread?
One should use a Bull Calendar Spread when one wishes to profit from an underlying asset that is expected to stay stagnant or with slight bullish inclination.
How To Use Bull Calendar Spread?
Establishing a Bull Calendar Spread is extremely simple. All you have to do is to purchase an In the Money (ITM) LEAP and then sell At the Money (ATM) or Out of the Money (OTM) near term calls against the LEAP.
Example : Assuming QQQQ trading at $45 now.
Buy To Open 10 contracts of QQQQ Jan 2008 $44 Call options at $5.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Call at $0.75.
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We use In The Money (ITM) LEAPs instead of At The Money (ATM) or Out of The Money (OTM) ones so that the Delta value (read about what Option Delta and other option greeks are.)
of the LEAPs are higher than the Delta value of the short term options. This is to ensure that the LEAPs rise in value faster than the short term calls should the underlying asset stage a rally.
Trading Level Required For Bull Calendar Spread
A Level 3 options trading account that allows the execution of debit spreads is needed for the Bull Calendar Spread. Read more about Options Account Trading Levels.
Profit Potential of Bull Calendar Spread :
A Bull Calendar Spread profits when the underlying asset closes at or below the strike price of the short call options. The short call options
then expires out of the money and you make the full value of the short call options. The Bull Calendar Spread's maximum profit occurs when the underlying asset closes exactly at the strike price of the short call options at expiration of the short call options.
From the above example : Assuming QQQQ close at $45 on the third Friday (option expiration day) of Jan 2007.
You will make the $750 value of the 10 Jan 2007 $45 Call options that you wrote as they expire out of the money, less,
the decay of the 10 contracts of Jan 2008 $44 Call options.
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The profitability of a bull calendar spread can also be enhanced or better guaranteed by legging into the position properly.
Profit Calculation of Bull Calendar Spread:
Profit = Long Call Value - Net Debit
From the above example : Assuming QQQQ close at $45 as mentioned above
and QQQQ Jan 2008 $44 Call Options are trading at $5.60 then.
Profit = $5600 - $4950 = $650
Profit % = $650 / $4950 = 13.13%
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Risk / Reward of Bull Calendar Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
Break Even Point of Bull Calendar Spread:
The breakeven point of a Bull Calendar Spread is the point below which the position will start to lose money if the underlying asset falls.
Break Even = Stock Price when long call value is equal to net debit
The long call value at different prices can only be calculated using the Black-Scholes model.
Advantages Of Bull Calendar Spread:
:: Able to profit even if underlying asset stays stagnant.
:: Able to offset losses if underlying asset drops in value.
:: Buying the LEAP in lieu of the stock can generally allow the underlying asset to be controlled at a discount.
:: Losses are limited to the net debit.
:: Losses are limited to the net debit.
Disadvantages Of Bull Calendar Spread:
:: Profits are limited even if the underlying asset rallies.
:: Losses can be sustained if the short call options are assigned when the underlying asset rallies.
Adjustments for Bull Calendar 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 underlying asset to continue its profit run.
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