Calendar Spreads

Question 1

How do you set up a Calendar Spread?

Answer 1

Sell a near-term option and buy a longer term option of the same series (call or put) on the same stock with the same strike price.
(e.g. buy April calls and sell March calls or Buy April puts and sell March puts)

Question 2

1. Finish the sentence:
   “You bought an ATM February option for $8 and sold the ATM January option at $6 for a net $2 debit. If the stock stays the same price by January, _____ “

Answer 2

the January option will have zero time value and the February option will have $6 time value remaining

Question 3

Is there intrinsic value on calendar spreads? Why or why not?

Answer 3

No – the buy and sell positions have the same strike price, so they perfectly oppose each other in their intrinsic value

Question 4

What is your max loss in a calendar spread?

Answer 4

the debit you paid

Question 5

what is salvage value?

Answer 5

since the far-month option will have some time value left as soon as your near-month option fully expires, you collect salvage value

Question 6

How can you avoid losing the debit you paid IN FULL on a calendar spread?

Answer 6

sell the far-month option when there is still time remaining on it (after near-month has expired)

Question 7

When does the calendar spread maximize value?

Answer 7

when the near-term option expires and the far term option still has a full month or more of time value remaining AND when the stock lands at the strike price, not above or below.

Question 8

if you buy an OTM time spread, what is your strategy?

Answer 8

you believe the stock will move toward your strike price at the near-term expiration