Calendar Spread Options Strategy & Adjustments | Income Strategy | Nifty Live Example

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In this video we would be learning about the Calendar Spread options strategy and also how to adjust a troubled Calendar Spread position.

Calendar Spread Options Strategy:

Calendar spreads, also known as horizontal spreads, consist of two options of the same type (either call or put) and same strike price, but have different expirations. Though it is a neutral to bullish strategy, you do not anticipate a big movement in the underlying, as if the underlying rises significantly it could harm your position.

It is the sale of a near term expiration option and the purchase of a far term expiration option. Both options share the same strike price and the strike price is usually near the money.

Calendar spread is a net debit trade as you would be paying more premium for the far term expiration option than you would be collecting for the near term expiration option.

Income Strategy:

Calendar spread can also be seen as an income strategy. The idea is by selling near term expiration options against the far term expiration option and collecting the premium you should be able to generate a consistent income.

You take advantage of the fact that the time decay of the near term options is faster than the far term options.

The far term expiration option should be at least 2-3 months to expiration, while the near term option should either be weekly or monthly.

The effect of time decay (theta) and an increase in volatility (vega) is positive for the strategy.

Let’s look at an Example:

Nifty is at 9881.15 on June 17th, 2020. A Calendar Call spread can then be entered as follows:

Sell one lot of 25th June 10000 Call option at 127.35
Buy one lot of 31st December 10000 Call option at 715.15

Risk Graph:

From the risk graph of the Calendar Call spread it is evident that while it is a neutral to bullish strategy if the underlying rises significantly it could harm the position. So a range bound to slightly bullish movement is what is beneficial to the position. Maximum profit is achieved when the underlying on expiration date is trading right at the strike price where the strategy has been initiated.

Adjustments:

Say 4 days into the trade, Nifty rose to 10000.

First adjustment: If you anticipate the index to rise further, roll out and up the sold 25th June 10000 Call option. That is, buy to close the 25th June 10000 Call option and sell to open the 31st December 10500 Call option.

The position would then look like this -

Sell one lot of 31st December 10500 Call option at the cmp on that day
Buy one lot of 31st December 10000 Call option at 715.15

This creates a Bull Call spread position which would benefit from the anticipated bullish movement of the index.

Risk graph: This adjustment would help you if the index continues to move up.

Second adjustment: If you anticipate the index to rise further, buy to close the 25th June 10000 Call option and sell to open two lots of the 27th August 10200 Call option.

The position would then look like this -

Sell two lots of 27th August 10200 Call option at the cmp on that day
Buy one lot of 31st December 10000 Call option at 715.15

This creates a ratio diagonal spread position which would benefit from the anticipated bullish movement of the index.

Risk Graph: This adjustment not only removes the entire downside risk but also pushes the upside break even point farther away.

Say 4 days into the trade, Nifty dropped to 9600.

Third adjustment: If you anticipate the index to drop further, construct both a short strangle and a long strangle at the level to which the index dropped to. That is, sell to open the 25th June 9600 put option and Buy to open the 31st December 9600 put option.

The position would then look like this -

Sell one lot of 25th June 9600 Put option at the cmp on that day
Sell one lot of 25th June 10000 Call option at 127.35
Buy one lot of 31st December 10000 Call option at 715.15
Buy one lot of 31st December 9600 Put option at the cmp on that day

This creates a short strangle position and a long strangle position at the strike prices 9600/10000.

Risk Graph:

The short strangle and long strangle combination creates a wider profit zone.

Let us know in the comments section which adjustment you see as the least complicated and easier to implement.