Equity and Index Options Explained

28

Long Put Calendar Spreads

A long put calendar involves buying a longer-dated put against selling a shorter-dated put. For example, from Table 28.1 (repeated from Table 25.1) of Sep and Dec FTSE 100 option prices, buying the Sep/Dec 5325 put calendar consists of two legs (highlighted), buying the Dec 5325 put at 185 ticks (equivalent to £1850) per put and simultaneously selling the Sep 5325 put at 53 ticks (equivalent to £530) per put. The price of the calendar is therefore 132 ticks (equivalent to £1320) per spread, the difference between the 185 paid for the Dec put and the 53 received for the Sep put. 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 long put calendar, we are looking primarily to reduce the cost of owning options. We want to buy some out-of-the-money Dec puts but are not willing to buy them outright, either because we do not perceive them to be cheap enough and/or because we do not expect the underlying FTSE Index to fall sufficiently. We reduce the cost of the trade by selling some similarly out-of-the-money Sep puts at the same time. We part-finance the purchase of the Dec puts by selling some Sep puts. Unsurprisingly, by reducing cost, we are simultaneously limiting our profit potential.

Table 28.1 LIFFE Sep and Dec FTSE 100 option prices as at close on 26 August 2008 (Sep FTSE 100 future = 5494, Dec ...