So what can you do when you want to profit from a stock that isn’t going anywhere? It just sits there like a kid experiencing a sugar crash, yet you want it to bring some joy to your life.
Well, the Calendar Call Spread is a neutral options strategy that profits from this situation.
The upside comes from the difference in rate of premium decay between near-term short options and the long-term LEAPs. That’s because those near-term option premiums decay faster than long-term option premiums, kind of like fruit left outdoors stinks up the place faster than an unopened can of soda.
Mind you, the LEAPS you buy are going to be more expensive than the options you sell near-term, so it begins with a net debit.
There are two different methods to establish this calendar call spread. The first is to buy and sell options of different expiration months, but at the same strike price (horizontal spread). The second is to buy and sell options of different expiration months and different strikes (diagonal spread). The goal is that you want to profit while the stock stays stagnant, but still enjoy upside if the stock happens to break out.
For the horizontal spread, buy an at-the-money LEAP call option, and sell at-the-money call options closer in.
For the diagonal spread, buy an in-the-money LEAP call option, and sell either an at-the-money or out-of-the-money call closer in.
So how much can you make using this strategy?
In both cases, your maximum profit occurs when the underlying stock closes at the strike price of the short call options during expiration of the short call options. Your maximum profit and loss are both limited. Your breakeven point is harder to peg, because the underlying stock could rise or fall sharply, and the time premium will be shifting, so there’s no way to ascertain that.
One thing to be careful of is the short call options get assigned to you if that underlying stock moves up sharply. In that case, you can buy back that short call, thus allowing your LEAPS to increase in value.
Let’s look at a real-world example.
One of the stocks I like to use here is General Electric (NYSE:GE). The stock moves very little, but generally increases over time, although it tends to sell off or fly high in massive overall market moves. As I write, the stock is at $22.29.
Horizontal Spread: I’m going to buy a January 2015 $22 Call for $2.31. I’m going to sell a January 2014 $22 Call for $1.41. So my net debit is 90 cents, or $90 for a contract. Let’s say GE just sits there until January 2014 at $22. That call expires worthless. You hold the January 2015 $22 Call, which you paid $90 for. So if GE hits $22.90 before the January 2015 expiration date, you’ll break even — and if it goes higher, it’s all profit. If GE never gets that high, you’ve only spent $90.
Diagonal Spread: I’m going to buy a January 2015 $20 Call for $3.44. I’m going to sell a January 2014 $23 Call for 98 cents. So my net debit is $2.46, or $246. Let’s say GE just sits there until January 2014 at $22. That call expires worthless. You hold the January 2015 $20 Call, which you paid $246 for. So if GE hits $22.46 before the January 2015 expiration date, you’ll break even — and if it goes higher, it’s all profit. If GE never gets that high, you’ve only spent $246.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.