Reverse Calendar Spread Option Strategy
What are the characteristics of this option strategy?
A reverse calendar spread option strategy is an advanced option strategy that involves simultaneous buying of a long-term option and selling a shorter-term option of the same type and underlying asset. This strategy looks to benefit from a “time decay” or “theta” effect as the shorter-term option expires. The reverse calendar spread option strategy is also known as “time spread” or “calendar spread.”
Is this a bullish, bearish or neutral strategy?
The reverse calendar spread option strategy is a neutral strategy as the outcome of the strategy will be dependent on the movement of the underlying asset during the period that the strategy is in place as opposed to a strong bullish or bearish view.
Is this a beginner or an advanced option strategy?
This is an advanced option strategy and is not suitable for novice traders. It involves complex option calculations, understanding of option “theta” or time decay, knowledge of volatility and the usage of the Greek ”Delta.” Professionals can use this strategy to reduce risk or generate income when they are unsure of the direction of the underlying asset.
In what situation will I use this strategy?
The reverse calendar spread option strategy is typically used when the trader expects the underlying asset to remain within a range or when the volatility of the underlying asset is high and the trader expects it to decrease over the time period of the strategy. It can also be used when a trader expects the underlying asset decile’s monthly volatility.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
This strategy typically provides a low risk/low reward outlook. The maximum potential loss is limited to the cost of the premiums while the maximum potential reward is the net credit received. The probability of profit is typically moderate but depends on the underlying asset, market conditions, and other factors.
How is this strategy affected by the greeks?
The main affect of the greeks on this strategy is “theta” or time decay. The reverse calendar spread strategy is sensitive to time decay, as the shorter-term option will lose value faster than the longer-term option. As such, the position has to be opened and monitored over a longer period of time in order to maximize profits.
In what volatility regime (i.e VIX level) would this strategy be optimal?
Ideally, this strategy prefers high volatility as the spread between the premiums of the two options is higher, providing the opportunity for a greater credit. However, when the volatility is too high, the underlying asset might move faster than expected and may resulting in large losses. Thus, having moderately high volatility provides the optimal environment for this strategy.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
When the trade goes against you, the main adjustment would be to manage the delta risk, by rolling out the short option to further out or further away from the money. This strategy can be difficult to adjust as the market has to offer enough liquidity in order to manage the delta risk.
Where does this strategy typically fall in the range of commissions and fees?
The commission and fees for this strategy can be quite high as it involves multiple options with different expiries, leading to higher commissions and fees. In addition, traders may forgo additional fees for options adjustment, depending on the complexity of the adjustment.
Is this a good option income strategy?
The reverse calendar spread option strategy can be a good option income strategy as it typically has a low risk/reward outlook. The maximum potential gain is the net credit received while the maximum potential loss is the cost of the premiums.
How do I know when to exit this strategy?
Traders should exit the reverse calendar spread option strategy when the underlying asset moves to limit their max potential loss or when they are in a position to take profits. Knowing when to exit can be difficult as the market conditions may change quickly, so traders need to continuously monitor the position.
How will market makers respond to this trade being opened?
Market makers may respond to this trade by providing wider bid/ask prices in order to hedge their risk. As this strategy can be difficult to adjust and requires longer observation time, some market makers may try to avoid this strategy.
What is an example (with calculations) of this strategy?
Here’s an example of the Reverse Calendar Spread option strategy using the stock MSFT, which is trading at $285:
Assuming that we expect MSFT’s price to remain relatively stable in the short term but to increase in the long term, we could use the Reverse Calendar Spread option strategy to profit from this. In this case, we could set up the following trade:
Buy 1 MSFT call option with a strike price of $290 and an expiration date of four months for a premium of $15.00
Sell 1 MSFT call option with a strike price of $290 and an expiration date of one month for a premium of $5.00
The net cost of this trade is $10.00 ($15.00 for the long-term call option minus $5.00 for the short-term call option). If MSFT’s price remains around $285 for the next month, the short-term call option will expire worthless, and we will have reduced our cost basis by $5.00. We can then sell another one-month call option and continue to reduce our cost basis until the long-term call option reaches its expiration date in six months.
If MSFT’s price increases significantly in the long term, the long-term call option will be in the money, and we can profit from the trade. The profit potential for the Reverse Calendar Spread option strategy is unlimited if MSFT’s price increases significantly in the long term.
MarketXLS
MarketXLS is a powerful spreadsheet application that enables traders to comply with complex option strategies, like the reverse calendar spread option strategy. It includes several advanced features such as auto-calculation of option Greeks and expiration prices, shows intraday option volatility and offers trading for more than 40 brokers. MarketXLS is a great tool for traders of all levels to learn and understand the complexities of option strategies and help them in making profitable trades.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/