Long Call Calendar Spread Option Strategy

The long call calendar spread is a popular options strategy involving two call options with the same strike price but differing expiration dates. This strategy combines one short call with a nearer expiration and one long call with a longer expiration. The objective of the long call calendar spread is to profit from the time decay and potential volatility difference between the two options, while limiting the overall risk exposure.

Introduction

This strategy is typically employed when an investor holds a neutral to moderately bullish or bearish view on the underlying stock. The strategy works best when the stock is forecasted to trade within a specific range or near the strike price over a defined period. By establishing this spread, an investor can potentially generate profits while managing risk through a controlled, limited position.

In this setup, the investor aims to balance the risks and rewards of the individual call options. A key goal of the long call calendar spread might include:

  1. Profit from a Range-Bound Stock Price: The investor anticipates that the stock will hover around the strike price, generating profits through time decay in both options while limiting risk exposure.

  2. Profit from a Directional Move Toward the Strike Price: The investor expects the stock to move toward the strike price, willing to accept limited risk if the stock moves away from the strike price.

What is a Long Call Calendar Spread?

A long call calendar spread consists of two calls: one long call with a later expiration and one short call with an earlier expiration, both at the same strike price. This strategy is designed for a net debit and offers limited risk and potential profit.

For example:

  • Sell 1 ABC (Month 1) 120 call

  • Buy 1 ABC (Month 2) 120 call

In this case, the strategy is implemented for a net debit, and the investor’s risk and reward are clearly defined at the time of the trade.

Additional Considerations

The maximum profit for a long call calendar spread is realized when the stock price is exactly at the strike price of the options at the expiration of the short call. The stock’s price at expiration determines whether the strategy is profitable or not, and the forecast for the price movement plays a crucial role:

  • Neutral Outlook: If the stock price is at or near the strike price when the position is established, the forecast is neutral, expecting little to no price movement.

  • Mildly Bullish Outlook: If the stock price is below the strike price when the position is created, the investor expects the stock to rise toward the strike price by expiration.

  • Mildly Bearish Outlook: If the stock price is above the strike price when the position is initiated, the investor forecasts the stock will fall toward the strike price at expiration.

This strategy is sometimes called a "long time spread" or "horizontal spread." The term "time" reflects the differing expiration dates, and "horizontal" refers to the listing format of options, where expiration dates are displayed horizontally.

Example Scenario

Consider stock ABC, currently trading at $120. The investor sets up a long call calendar spread by selling a short-term call and buying a long-term call, both with a strike price of $120.

  1. Sell 1 ABC (Month 1) 120 call for $2.50 (total premium received = $250)

  2. Buy 1 ABC (Month 2) 120 call for $3.90 (total premium paid = $390)

In this case, the net debit to establish the position is $140 (ignoring commissions and fees).

Profit and Loss Analysis

Maximum Profit:

The maximum profit occurs if the stock price equals the strike price on the expiration date of the short call. At this point, the long call will have the highest time value, and the short call will expire worthless. The profit potential is at its maximum when the time decay on the short call works in favor of the position, and the long call retains its value.

The maximum profit is determined by the difference in the time value between the long and short calls, at expiration, based on market volatility.

Maximum Loss:

The maximum loss happens when the stock price moves sharply away from the strike price in either direction. In this case, both options lose their time value, and the spread loses value as a result. The maximum loss is equal to the net premium paid to establish the position.

For example, if the stock price significantly deviates from the strike price, the time value of both options diminishes, leading to a loss equal to the net debit.

Max Loss = Total Net Premium Paid
= $140 (not including commissions and fees)

Breakeven Points:

There are two potential breakeven points in a long call calendar spread, one above the strike price and one below. These breakeven points occur when the time value of the long call equals the total cost of the spread.

The breakeven points depend on the level of volatility and time decay, making it challenging to predict the precise stock prices at which breakeven occurs.

At-A-Glance Summary

Strategy: Long Call Calendar Spread
Alternative Name: Call Horizontal
Pre-Requisite Strategy Knowledge: Long Call, Short Call
Legs of Trade: 2 legs
Sentiment: Neutral to Modestly Bullish/Bearish
Example:

  • Sell 1 ABC (Month 1) 120 call

  • Buy 1 ABC (Month 2) 120 call
    Max Potential Profit (Gain): Back month premium — front month premium — total net debit to establish position
    Max Potential Risk (Loss): Total Net Premium Paid
    Ideal Outcome: ABC price trades at or near the strike at expiration
    Early Assignment Risk: Applies to the short call (nearer-dated expiration) only

Risks and Risk Mitigation

The long call has no risk of early assignment, as it has the later expiration date. However, the short call, with the nearer expiration, carries the risk of early assignment. If the short call is assigned early, the investor will need to sell stock and create a short stock position. If the investor does not wish to hold the short stock position, they can either close the entire spread or buy back the short call.

In the case of early assignment, the result will be a two-part position consisting of a short stock position and the long call. If the stock price moves according to the investor’s forecast, the position can generate substantial profits. If the short stock position is unwanted, the investor must decide whether to exercise the long call or purchase the stock in the market to close the position.

Early assignment risk should always be considered when entering a calendar spread, particularly with the short call leg.