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Calendar Straddle

How Does Calendar Straddles Work in Options Trading?

Calendar Straddle Risk Graph
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Calendar Straddle - Introduction

The Calendar Straddle is a neutral options strategy designed to profit when a stock is expected to moved within a tight channel in the short term while still keeping the potential for profiting should the stock stage a breakout. The Calendar Straddle produces this effect by buying a long term straddle while writing a short term straddle.

Indeed, the Calendar Straddle is a Calendar Spreads that optimizes profit through the higher rate of time decay of the short term straddle versus the long term straddle while allowing you the option of simply keeping the long term straddle without the short term straddle anytime the underlying stock is expected to stage an explosive breakout.

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When To Use Calendar Straddle?

One should use a Calendar Straddle when the underlying stock is expected to remain stagnant in the short term while expected to stage a breakout in either direction in the longer run. This is especially useful leading up to a potential volatile event which is due in a few months. Such events may be important court verdicts or results of an important R&D development. The few months leading up to such an event would see implied volatility increase steadily, resulting in higher extrinsic values and steadier price levels which favors short term short straddles. On the month of the volatile event itself, the short term straddle could be closed and the longer term straddle held on to in order to profit from the expected breakout due to the volatile event.

How To Use Calendar Straddle?

Calendar Straddles simply consist of a near term short straddle and a longer term long straddle. This means buying longer term at the money call and put options while shorting the same amount of nearer term at the money call and put options.

Buy Long Term ATM Call + Buy Long Term ATM Put + Short Near Term ATM Call + Short Near Term ATM Put

Calendar Straddle Example :

Assuming XYZ trading at $44. It is February and XYZ is awaiting an important court verdict in June.
Its Jun44Call is quoted at $2.10, its Jun44Put is quoted at $2.00, its Mar44Call is quoted at $1.00 and its Mar44Put is quoted at $0.80.
Buy To Open QQQQ Jun44Call, buy To Open QQQQ Jun44Put
Sell To Open QQQQ Mar44Call, sell To Open QQQQ Mar44Put

Net Effect: ($2.10 + $2.00) - ($1.00 + $0.80) = $2.30 net debit.

In the above example, the Calendar Straddle is used to profit from the rising short term extrinsic values of the near term short straddles while having a June long straddle in place for the court verdict in June. In this case, new short term straddles would be written for the month of April and May while in the end leaving the June long straddle open for the court verdict which will either explode the stock price upwards or downwards.

Profit Potential of Calendar Straddle:

You would notice above that the Calendar Straddle has the potential to make money in 2 ways; 1, through the higher rate of time decay between the short straddle and the long straddle. 2, through the long straddle on a price breakout. Unless the Calendar Straddle is placed based on an expected volatile event sometime in the future so that eventually the long straddle position can be made used of for profit, there are better neutral options strategies for use on stocks that are totally not expected to stage any breakouts.

Profit Calculation of Calendar Straddle:

Maximum Profit = Difference in time decay between short term straddle and long term straddle. Specific prices needs to be calculated using an options pricing model such as the Black-Scholes Model.

Maximum Loss Possible = Net Debit Paid

Calendar Straddle Example Continued :

Maximum Loss Possible = $2.30

Risk / Reward of Calendar Straddle:

Maximum Profit: Limited in the short term when near term short straddles are written. Unlimited in the long term when the position is transformed into a simple long straddle.

Maximum Loss: Limited to net debit. This happens when the underlying stock stages an explosive breakout in either direction.

Break Even Points (Profitable Range) of Calendar Straddle:

Breakeven points of Calendar Straddle can only be determined through the use of an options pricing model such as the Black-Scholes Model.

Advantages Of Calendar Straddle:

:: Able to profit when stock remains stagnant for the short term

:: Flexibility to transform the position into a long straddle when the stock is expected to stage a breakout.

:: Loss is limited.

:: No margin needed.

Disadvantages Of Calendar Straddle:

:: The position would result in a loss should the stock stage a breakout suddenly.

:: There are 4 legs to this trade which may require legging into the position in order to ensure or enhance profitability.

Alternate Actions for Calendar Straddle Before Expiration :

1. If the underlying stock is expected to stage a breakout soon, simply allow the short straddle to expire without rolling forward or closing out the short straddle. This transforms the position into a Long Straddle which profits when the underlying stock breaks out to upside or downside.

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