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How to Give a Calendar Spread Bullish or Bearish Direction

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Calendar spreads can be used for more than establishing neutral positions.

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All of the above assumes no change in implied volatility between now and July 19. If implied volatility rises, the time value in both options will increase, but the Septembers will increase more, since they have more time value to start with. Since we are net long time value, increasing volatility would improve the P/L for this position.

That's how a neutral calendar works. So how could this be made into a directional (bullish or bearish) position? That's easy. Note from the diagram above that the peak in the P/L curve occurs at the 161 strike price. If we choose a different strike price, the P/L peak will be at that price. If we are bullish, we could just choose a higher strike price. Suppose we believe that SPY could go as high as 168 by July 19. We could use that strike for our calendar, placing the P/L peak at that price.

Below is the diagram for a July/September call calendar at the 168 strike, which we could have entered for a net debit of $1.53.



Note that the profit peak is at the 168 strike, about $7.00 above the current price. At $168, the max profit on this spread would be $2.27 on our $1.53 investment if it occurred on July 19 and somewhat less if it happened right away ($.95 if it happened today). By choosing a different strike, we have turned this into a bullish trade. We would have to be sure to close this position as soon as SPY hit $168 because profit declines above that.

The bullish calendar is an alternative that works well when we are bullish and volatility is expected to rise. It is well worth examining in these conditions, as an alternative to a vertical spread. Like the vertical spread, it gives substantial positive delta (profit from rising underlying price) at a low price and reduces time decay substantially compared to purchasing calls alone. Depending on the specific conditions, the calendar may well be the best choice in a given situation.

Editor's note: This story by Russ Allen originally appeared on Online Trading Academy.

To read more from Online Trading Academy, see:

Where Are the Markets Going?

The Rupee

The Role of Feedback to Skillful Trading
No positions in stocks mentioned.
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