Calendar and Diagonal Spreads

Russell Rhoads, CFA – The Options Institute

Disclosure
In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in
the examples used in this presentation. These costs will impact the outcome of all stock and options
transactions and must be considered prior to entering into any transactions. Multiple-leg strategies involve
multiple commission charges.
Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative
and educational purposes only and are not to be construed as an endorsement, recommendation, or
solicitation to buy or sell securities.
Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor
must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your
broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite
500, Chicago, Illinois 60606. Under section 1256 of the Tax Code, profit and loss on transactions in certain
exchange-traded options are entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital
gain or loss, provided that the investor involved and the strategy employed satisfy the criteria of the Tax Code.
Investors should consult with their tax advisors to determine how the profit and loss on any particular
option strategy will be taxed. Tax laws and regulations change from time to time and may be subject to
varying interpretations.
CBOE, Chicago Board Options Exchange, MNX, OEX, XEO and XSP are registered trademarks and The Options
Institute and Weeklys are service marks of Chicago Board Options Exchange, Incorporated (CBOE). SPXpm is a
service mark of C2 Options Exchange, Incorporated (C2). Standard & Poor's®, S&P®, S&P 100® and S&P 500®
are registered trademarks of Standard & Poor's Financial Services, LLC and have been licensed for use by CBOE
and C2. All other trademarks and service marks are the property of their respective owners.

CBOE is not affiliated with Interactive Brokers

Copyright © 2012 CBOE. All rights reserved. 2

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Outline

• Review of Time Decay

• Calendar Spreads
• Diagonal Spreads
• LEAPS® Stock Substitute

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Time Decay
120 Day Time Value Behavior –
3.50

ITM
3.00
ATM
2.50
OTM

2.00

1.50

1.00

0.50

0.00
120 100 80 60 40 20 0

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Time Decay
30 Day Time Value Behavior –
1.75

ITM
1.50
ATM
1.25
OTM

1.00

0.75

0.50

0.25

0.00
30 25 20 15 10 5 0

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Time Decay
7 Day Time Value Behavior –
0.80

ITM
ATM
0.60
OTM

0.40

0.20

0.00
7 6 5 4 3 2 1 0

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Time Decay

XYZ – At-The-Money Time Decay –

Days to Stock XYZ XYZ

Expiration Price 40 Call 40 Put
7 40.00 0.67 0.66
6 40.00 0.62 0.61
5 40.00 0.57 0.56
4 40.00 0.51 0.50
3 40.00 0.44 0.43
2 40.00 0.36 0.35
1 40.00 0.25 0.24
0 40.00 0.00 0.00

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Time Decay

XYZ – In-The-Money Time Decay –

Days to Stock XYZ XYZ

Expiration Price 39 Call 41 Put
7 40.00 1.28 1.28
6 40.00 1.24 1.24
5 40.00 1.20 1.19
4 40.00 1.15 1.14
3 40.00 1.10 1.09
2 40.00 1.06 1.05
1 40.00 1.01 1.01
0 40.00 1.00 1.00

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Time Decay

• Based on different factors – time value

deteriorates at different rates
• This difference in time decay may be taken
advantage of through spread trades
• Consideration should always be given to having
time decay working for you when choosing a
strategy

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Calendar Spread

VRM @ 40.00
• 30 Days to November expiration
• 90 Days to January expiration
• Neutral on VRM for next 30 days

Sell 1 VRM Nov 40 Call @ 1.15

Buy 1 VRM Jan 40 Call @ 2.00
Net Cost = 0.85

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Calendar Spread

November Expiration Payout Table –

Short 1 Long 1
VRM Nov VRM Jan
VRM 40 Call 40 Call Debit P/L
30.00 0.00 0.05 (0.85) (0.80)
35.00 0.00 0.15 (0.85) (0.70)
40.00 0.00 1.65 (0.85) 0.80
45.00 (5.00) 5.30 (0.85) (0.55)
50.00 (10.00) 10.10 (0.85) (0.75)

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Calendar Spread

Payout Diagram –
1.00

0.75

Max Gain
0.50

0.25

0.00

-0.25

-0.50

-0.75

Max Loss
-1.00

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Calendar Spread

Trading Decision 1 –
If VRM is over 40.00 at expiration –

• Cover short option to avoid assignment

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Calendar Spread

Trading Decision 2 –
Jan 40 Call position open at November expiration

• Trade Complete – Sell Jan 40 Call

• Bullish on VRM – no trade – hold long call
• Neutral on VRM – Sell Dec 40 Call – create
new calendar spread

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Diagonal Spread

• Long one option – short another option

• Both are same type (put or call)
• Difference number one is strike price
• Difference number two is in the expiration date

Short 1 XYZ Nov 50 Call

Long 1 XYZ Dec 40 Call

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Diagonal Spread

VRM @ 40.00
• 30 Days to November expiration
• 90 Days to January expiration
• Neutral to Bullish on VRM for next 30 days

Sell 1 VRM Nov 40 Call @ 1.15

Buy 1 VRM Jan 30 Call @ 10.10
Net Cost = 8.95

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Diagonal Spread

November Expiration Payout Table –

Short 1 Long 1
VRM Nov VRM Jan
VRM 40 Call 30 Call Debit P/L
30.00 0.00 1.25 (8.95) (7.70)
35.00 0.00 5.15 (8.95) (3.80)
40.00 0.00 10.05 (8.95) 1.20
45.00 (5.00) 15.05 (8.95) 1.10
50.00 (10.00) 20.00 (8.95) 1.05

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Diagonal Spread

Payout Diagram –
2.00

Max Gain
0.00

-2.00

-4.00

-6.00
Max Loss

-8.00

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Diagonal Spread

Trading Decision 1 –
If VRM is over 40.00 at expiration –

• Cover short option to avoid assignment

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Diagonal Spread

Trading Decision 2 –
Jan 30 Call position open at November expiration

• Trade Complete – Sell Jan 40 Call

• Bullish on VRM – no trade – hold long call
• Neutral on VRM – Sell Dec 40 Call – create
new calendar spread

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LEAPS Diagonal

Long-term Equity AnticiPation Securities –

• Long dated options with expirations over nine
months in the future
• LEAPS call be used as a substitute for the long
stock leg of a covered call
• Be aware – no voting rights and no right to a
dividend accompany LEAPS ownership

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LEAPS Diagonal

Late February 2012 – VRM @ 38.50

• Long term bullish on VRM
• Believe stock has resistance at 40.00
• This resistance should hold for the next few
weeks

Buy 1 VRM Jan 2014 LEAPS 30 Call @ 10.40

Sell 1 VRM Apr 40 Call @ 0.85

Time Value 10.40 – 8.50 = 1.90

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LEAPS Diagonal

April Expiration –

Jan 2014
LEAPS 30 Apr 40 Call Spread
VRM Call Value Value Cost Net P/L
30.00 4.15 0.00 (9.55) (5.40)
35.00 7.55 0.00 (9.55) (2.00)
38.50 10.30 0.00 (9.55) 0.75
40.00 11.60 0.00 (9.55) 2.05
45.00 16.05 (5.00) (9.55) 1.50

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LEAPS Diagonal

April Expiration
2.00

Max Gain
0.00

-2.00

-4.00

-6.00 Max Loss

-8.00

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LEAPS Diagonal

Trading Decision 1 –
If VRM is over 40.00 at expiration –

• Cover short option to avoid assignment

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LEAPS Diagonal

Trading Decision 2 –
LEAPS Call position open at November expiration

• Near term bullish on VRM – no trade – hold

long LEAPS
• Near term neutral on VRM – Sell another call –
create new diagonal spread
• Not bullish on VRM anymore – Sell LEAPS

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LEAPS Diagonal

Summary –
• Trade allows the benefit of long term stock
ownership combined with generating income
• Due to long life of LEAPS call there may be
multiple option selling opportunities over the life
of a trade
• Stocks that have both LEAPS and Weeklys
listed may be attractive for this strategy

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Summary

• When selling options a trader can have the

opportunity to take advantage of time decay
• Multiple strikes and expiration dates create a
wide variety of opportunities
• With the introduction and popularity of Weeklys
the ability to benefit from time decay has greatly
expanded

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Info / Contact

Questions?

Links –
www.cboe.com/leaps
www.cboe.com/weeklys

Me –
[email protected]

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