Equity and Index Options Explained

27

Short Call Calendar Spreads

A short call calendar involves selling a longer-dated call against buying a shorter-dated call. For example, from the matrix of Sep and Dec FTSE 100 option prices shown in Table 27.1 (repeated from Table 25.1), selling the Sep/Dec 5625 call spread consists of two legs, selling the Dec 5625 call at 207 ticks (equivalent to £2070) per contract and simultaneously buying the Sep 5625 call at 51 ticks (equivalent to £510) per contract. The price of the calendar is therefore 156 ticks (equivalent to £1560) per contract, the difference between the 207 received for the Dec call and the 51 paid for the Sep call. What is the thinking behind such a trade?

Remember that option spreads have evolved for two main reasons; to reduce the cost of owning options and/or to reduce the risk of shorting options. In the case of a short calendar, we are looking primarily to reduce the risk of selling options. We want to sell some out-of-the-money Dec calls but are not willing to accept the unlimited risk that such a trade conveys. We reduce the risk of the trade by buying some similarly out-of-the-money Sep calls at the same time. We protect the sale of the Dec calls by buying some Sep calls. Unsurprisingly, by capping risk, we are simultaneously limiting our profit potential.

Table 27.1 LIFFE Sep and Dec FTSE 100 option prices as at close on 26 August 2008 (Sep FTSE 100 future = 5494, Dec FTSE 100 future = 5528)

So short call calendars are a “safer” way of selling calls, ...