Mini Chapter Thirteen
Calendar spreads
- Is a strategy to go short time decay by selling a shorter expiry option and buying a longer expiry one, both at the same strikes preferably with a less volatile underlying. If the price of the underlying remains relatively steady theta is the dominant greek and the shorter expiry option earns the buyer of the spread a larger time decay than what is spent on the longer expiry option. To maximise theta value of the spread, strikes are near or at the money.
- Delta would be negligible as a long and short ~ATMF strikes would cancel out each other
- Gamma would be negative having sold the short expiry ATMF (which is why you would prefer doing the strategy on a less volatile underlying) while vega would be positive having bought the longer expiry ATMF.
- To conclude for an equal notional spread this is a way to go long vega by financing it with short theta but being wary of the short gamma.
- Markets quote all variations of the calendar spreads i.e. on calls, puts and a long/short straddle.
- Graphs below represent a 100 ATM strike 1m vs 3m calendar spread – while the delta and gamma swings are sharp, the magnitude of the greeks isn’t meaningful at inception. Price sensitivity of the option at different implied vols shows that vega is the dominant greek in this strategy. In other words, this is akin to buying forward vol on the underlying too – with some short gamma to make the carry profile more attractive.
Graph 50 – Calendar Spread at different Implied Vols
Source: Pandemonium.
Graph 51 – Calendar spread Deltas at different Implied Vols
Source: Pandemonium.
Graph 52 – Calendar spread Gammas at different Implied Vols
Source: Pandemonium.
