Calendar Spread – The cheaper option strategy to the Covered Call

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An option strategy that I use consistently in the same vain to the Covered Call is the Calendar Spread. There are various different approaches to the Calendar Spread, either as a neutral approach or with a directional bias. And with a few simple rules, it can be a cheaper alternative for those who don’t have as much capital to invest.

Calendar Spread cheaper Option StrategyThere’s an old proverb: “It takes money to make money!” You can’t invest in the stock markets unless you have some capital to start with, and although the Covered Call is my favourite strategy and one of the most popular amongst Self Managed Superannuation investors, it requires a reasonable amount of capital to work effectively.

Last year I wrote an article titled “Trading Covered Calls on the US Market. Why I believe it is the opportunity of a Lifetime!” With more than 15 years experience in the markets as a trader and advisor, I have not seen any other strategy perform with as much consistency.

Some readers will scoff at the fact that the Covered Call strategy, on average, has lower returns than short-term trading or some other higher risk strategies. And by all means, it might not be as exciting as hearing hundreds of percent return on a trade. However, even the Australian Stock Exchange (ASX) promotes the Covered Call (also referred to as the Buy Write option strategy) as outperforming the broader stock market.

But what I would argue is that consistency, compounding and outperforming the markets even during Bearish conditions is far more beneficial towards long-term capital growth than the higher Risk of short-term speculative trading.

So how can you benefit from this option strategy with less capital available?

An alternative to the Covered Call option strategy is the Calendar Spread. Instead of purchasing shares and then selling calls against those shares, the Calendar Spread option strategy involves purchasing a longer-dated option and selling a shorter dated option against it. The bought option acts as cover for the sold option.

Just like the Covered Call, the Calendar Spread can benefit from Time Decay, from high Volatility, and from sideways trading stock prices. In addition to this, you can set your Calendar Spread up to have a directional bias as well.

The Risk of the calendar spread, and just like Newtons law of Motion – for every action there is an equal and opposite reaction, there is slightly more Risk with the Calendar Spread due to the fact that you are purchasing a longer-dated option compared to purchasing shares. Therefore, there is the potential for Time Decay in the bought leg of the option strategy.

There are two ways you can manage this Risk:

1. Buy enough time to be right. If your view for the underlying stock is for the next 3 months, purchase at least 6-months on the longer-dated option. This will help give you time to sell more options against the position and bring in more premium to cover the cost of the trade.

2. Buy a deeper In The Money (ITM) option as there is more intrinsic value. Option strikes that are closer to the current price will have more Time Decay and will fluctuate at different percentages compared to a deeper ITM option. If the position moves against you, it will retain more value. Therefore, provide better protection.

To provide a comparative example of recent trades conducted on the same stock with both a Covered Call and Calendar Spread option strategy, the following ANF (Abercrombie & Fitch: US) example provides a great distinction.

Calendar Spread Option Strategy

Both positions were entered on the 17th April, and closed on the 8th May:

Covered Call

Calendar Spread

Bought stock

$47.64

Bought Aug 36.00 Call

$12.25

Sold May 47.00 Call

$2.66 credit

Sold May 50.00 Call

$1.29 credit

Total cost per 100 shares

$44.98

Total cost per 1 option contract

$10.96

Total cost

$4,498.00

(exc brokerage)

Total cost

$1,096.00

(exc brokerage)

Closed May 47.00 Call

$4.85

Closed May 50.00 Call

$2.29

Sold stock

$51.59

Sold Aug 36.00 Call

$17.60

Gross return

$1.76 per share

Gross Return

$4.35 per share

% return

3.69%

% return

39.68%

Less capital is required to enter into the Calendar Spread option strategy, and with the same underlying stock price movement, a higher percentage return is possible. The trader must be fully aware that if the share price were to move against the position, that the Calendar Spread has the potential to lose a greater percentage, although dollar value will be determined by how much capital invested into the trade.

If you would like to know more about how you can benefit from using the Calendar Spread option strategy, or utilize the Calendar Spread strategy for your investment portfolio, feel free to contact me on brown@halifaxonline.com.au

Matthew Brown – US Stocks & Options specialist
Client Advisor

Halifax Investment Services
ASIC Australian Financial Services License Number – 225973

Matthew is an Authorised Representative of Halifax Investment Services (Halifax). Halifax provides broker services, including Full Service and Discount Services using multiple trading platforms. For Discount platform services, Halifax charges the same fees for phone service as the online trading platform.

Since 1998, Matthew has been involved in the Financial Services industry providing stock, option and CFD advisory services, trading advice, funds management and education services. Matt is an Authorised Representative of Halifax Investment Services, providing analysis and recommendations for trading Covered Calls in the US markets and using Exchange Traded Funds (ETFs) ...
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