Short Horizontal Calendar Call Spread

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Short Horizontal Calendar Call Spread - Introduction



The Short Horizontal Calendar Call Spread, also known as the Short Call Horizontal Calendar Spread or Horizontal Short Calendar Call Spread, is a volatile options trading strategy that profits when the underlying stock breaks out to upside or downside.

As a form of short calendar spread, the Short Horizontal Calendar Call Spread has the unique characteristic of having a much higher maximum potential profit than maximum potential loss, putting reward/risk ratio in your favor. Most other volatile options strategies has a larger maximum potential loss than maximum potential gain. As a credit spread, margin will also be required.

This tutorial shall explain what the Short Horizontal Calendar Call Spread is, how to use it and what its advantages and disadvantages are.

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Types of Short Calendar Call Spreads


There are two main kinds of Short Calendar Call Spread; Short Horizontal Calendar Call Spread and Short Diagonal Calendar Call Spread. The Short Diagonal Calendar Call Spread has a higher profitability than the Short Horizontal Calendar Call Spread if the underlying stock is expected to breakout to downside more than it will breakout to downside. The Short Horizontal Calendar Call Spread would have an equal profitability no matter which direction the stock breaks. As such, if the direction of breakout of the stock is uncertain, the Short Horizontal Calendar Call Spread would be a better choice than the Short Diagonal Calendar Call Spread.



Differences Between Short Horizontal Calendar Call Spread and Short Diagonal Call Time Spread


The Short Horizontal Calendar Call Spread has both a lower maximum profit potential but narrower breakeven points than the Short Diagonal Calendar Call Spread. The Short Horizontal Calendar Call Spread also has a much higher profit if the underlying stock break out upwards. This difference is due to the fact that out of the money call options are bought in the Short Diagonal Calendar Call Spread while at the money call options are bought in the short horizontal calendar call spread. Because out of the money call options with lower extrinsic value than at the money call options are bought in a Short Diagonal Calendar Call Spread, it has a higher maximum profit potential than the short horizontal calendar call spread but only when the stock breaks out downwards. Because at the money call options are bought instead of out of the money call options, a narrower breakeven point results due to greater rise in value of the call options when the stock breakout to upside.



When To Use Short Horizontal Calendar Call Spread?


Short Horizontal Calendar Call Spreads could be used when you wish to profit from a stock that has an equal chance of breaking out to upside or downside.

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How To Use Short Horizontal Calendar Call Spread?


In a Short Horizontal Calendar Call Spread, At The Money (ATM) LEAPS call options are written and ATM near term calls are bought.

Buy Short Term ATM Call + Sell Long Term ATM Call



Short Horizontal Calendar Call Spread Example
Assuming QQQQ trading at $45 now. Sell To Open 10 contracts of QQQQ Jan 2008 $45 Call options at $4.70.
Buy To Open 10 contracts of QQQQ Jan 2007 $45 Call at $0.75.
Net Credit = $4.70 - $0.75 = $3.95




Profit Potential of Short Horizontal Calendar Call Spread :


The Horizontal Short Horizontal Calendar Call Spread makes its maximum profit potential when the underlying stock stages a breakout to either upside or downside that is significant enough to wear out all of the extrinsic value on the long term short call options due to options moneyness.




Profit Calculation of Short Horizontal Calendar Call Spread:


Maximum profit = net credit

Maximum loss occurs when the underlying stock remains stagnant when the short term at the money call options expire worthless and the long term at the money call options do not reduce enough value due to time decay to offset the loss on the short term call options. Specific value can only be obtained using the Black-Scholes Model.

Short Horizontal Calendar Call Spread Example
Assuming QQQQ closes at $55 upon expiration of the short term call options.
Both long and short term $45 strike price call options are trading at $10.00 with no extrinsic value left.

Profit = net credit = $3.95

Assuming QQQQ remained stagnant and closed at $45 upon expiration of the short term call options.
The 10 contracts of QQQQ Jan 2007 $45 Call expired worthless.
The 10 contracts of QQQQ Jan 2008 $45 Call are trading at $4.30.

Net Loss = $0.75 - ($4.70 - $4.30) = $0.35




Risk / Reward of Short Horizontal Calendar Call Spread:



Upside Maximum Profit: Limited

Maximum Loss: Limited



Short Horizontal Calendar Call Spread Breakeven Calculation:


The breakeven point of a Short Horizontal Calendar Call Spread can only be calculated using the Black-Scholes model.



Advantages Of Short Horizontal Calendar Call Spread:



  • Greater maximum potential gain than maximum potential loss

  • Profit from stocks expecting to breakout in either direction

  • Narrower breakeven points than the Short Diagonal Calendar Call Spread



    Disadvantages Of Short Horizontal Calendar Call Spread:



  • Lower maximum potential gain than the Short Diagonal Calendar Call Spread

  • Margin is needed



    Alternate Actions for Short Horizontal Calendar Call Spreads Before Expiration :



    1. The moment the extrinsic value of the long and short term options are almost completely eroded due to a significant breakout, the position should be closed and profit taken. There is no need to hold til expiration because the engine that makes this options trading strategy work is the breakout, not time decay.


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