The Complete Book of Option Spreads and Combinations: Strategies for Income Generation, Directional Moves, and Risk Reduction, + Website

CHAPTER 6

Calendar Spreads

If we thought a company was going to report disappointing earnings we might want to buy a put option on that stock. We have a particular catalyst in mind, the upcoming earnings report, and we know when that report will be issued. We’re trying to get exposure for that catalyst, but we probably think that the stock will be mostly sideways until the event so we don’t want exposure for the entire period from now to the event.

We could buy that put option and we’d make money as long as the stock fell below the strike price of the put by more than the cost of the option. But lots of traders and investors are going to want exposure to, or protection from, that event, so they’re likely to bid up the price of the put option we’re thinking of buying. Is there a way to reduce the cost of buying the put that we want to own for that catalyst by selling a shorter-dated put that expires before the catalyst but that will erode away during the period between now and expiration, a period when we expect the stock will move sideways?

We might not have a particular event or catalyst in mind but might want to take advantage of the difference in option erosion by time to expiration that we discussed in Chapter 2. Shorter-dated options erode more quickly; their theta is higher, than longer-dated options. If we were to buy a longer-dated option and sell an option that was identical except for the time to expiration, that is, it was identical except for an earlier expiration ...