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Horizontal Put Time Spread - Introduction
The Horizontal Put Time Spread, also known as the Put Horizontal Time Spread, is a neutral strategy that profits from stocks that are expected to remain stagnant or trade sideways within a tight price channel. It is an options trading strategy that profits through the difference in time decay between long term options and short term options. Because of its long term position, one Horizontal Put Time Spread can be rolled forward for many months. Most other complex neutral options strategies needs to re-establish the whole position on a monthly basis. Another advantage of the Horizontal Put Time Spread is that it is a debit spread, thereby requiring no margin.
Types of Put Time Spreads
There are two main types of Put Time Spreads; The Horizontal Put Time Spread and the Diagonal Put Time Spread. Both Put Time Spreads are differentiated based on the moneyness of the short term put options written. As a Diagonal Spread, Diagonal Put Time Spread writes out of the money put options instead of at the money put options. As a Horizontal Spread, the Horizontal Put Time Spread writes at the money put options at the same strike price as the long term put options.
Differences Between Horizontal Put Time Spread and Diagonal Put Time Spread
The Horizontal Put Time Spread has both a lower maximum profit potential and a narrower profitable range (the stock needs to stay within a narrower price range in order to stay profitable) than the Diagonal Put Time Spread. However, the Horizontal Put Time Spread has a much higher profit if the underlying stock remained totally stagnant, closing at the same price as when the position was first put on. The Diagonal Put Time Spread has a higher maximum profit which only reaches when the underlying stock drops moderately. As such, if you think a stock is going to stay extremely stagnant, the Horizontal Put Time Spread would be your options trading strategy of choice versus the Diagonal Put Time Spread.
When To Use Horizontal Put Time Spread?
Horizontal Put Time Spreads could be used when you wish to profit from a stock that is expected to stay stagnant or trade within a tight price range for the short term while keeping a long term call option position in place in case of future breakouts.
How To Use Horizontal Put Time Spread?
In a Horizontal Put Time Spread, At The Money (ATM) LEAPS put options are bought and then ATM near term put options are sold.
Buy Long Term ATM Put + Sell Short Term ATM Put
Horizontal Put Time Spread Example
Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $45 Put options at $4.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Put at $0.75.
Net Debit = $4.70 - $0.75 = $3.95
Trading Level Required For Horizontal Put Time Spread
A Level 3 options trading account that allows the execution of debit spreads is needed for the Horizontal Put Time Spread. Read more about Options Account Trading Levels.
Profit Potential of Horizontal Put Time Spread :
The Horizontal Horizontal Put Time Spread makes its maximum profit potential when the stock closes at the strike price of the short term put options upon expiration of the short term put options.
Profit Calculation of Horizontal Put Time Spread:
The value of a Horizontal Put Time Spread during expiration of the short put options can only be arrived at using an options pricing model such as the Black-Scholes Model because the expiration value of the long term put options can only be arrived at using such a model.
Horizontal Put Time Spread Example
Assuming QQQQ closes at $45 upon expiration of the short term put options.
The 10 contracts of QQQQ Jan 2008 $45 put options is now trading at $4.30.
The 10 contracts of QQQQ Jan 2007 $45 put expired worthless.
Net Profit = $0.75 (total premium gained from the Jan 2007 $45 put) - $0.40 (total premium lost on the Jan 2008 $45 put)
= $0.35 x 1000 = $350.
Risk / Reward of Horizontal Put Time Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
(limited to net debit paid)
Horizontal Put Time Spread Breakeven Calculation:
The breakeven point of a Horizontal Put Time Spread is the point below which the position will start to lose money if the underlying stock rises or falls strongly and can only be calculated using the Black-Scholes model.
Advantages Of Horizontal Put Time Spread:
:: Able to profit even if underlying asset stays stagnant.
:: Can be rolled forward for as many months as the expiration month of the long term put options.
:: Losses are limited to the net debit.
:: No Margin Needed.
Disadvantages Of Horizontal Put Time Spread:
:: Profits are limited.
:: Much narrower profitable range and lower maximum profit than the Diagonal Put Time Spread.
Alternate Actions for Horizontal Put Time Spreads Before Expiration :
1. If you wish to profit from a drop in the underlying asset, you could buy back
the short put options before it expires and allow the LEAPS put Options to continue its profit run.
Questions About Horizontal Time Spreads
:: "How To Erase Margin Requirement In a Time Spread?"