Out of The Money (OTM) Long Call Calendar Spread

You create an out the money (OTM) call calendar spread setup by combining these two options:

1. Selling (writing, going short) a near-term call out the money (where the strike price is above the current stock price) with a short expiration typically less than 30 days) and,
2. purchasing (holding, long) a later-expiring call at the same strike price in step 1 above.  This position creates a net debit that you pay at trade entry. 

When establishing an out the money (OTM) call calendar spread, the legs of the spread are created by zeroing in on a stock you believe is bullish.

The spread allows us to play the appreciation of the stock with a significantly reduced capital outlay. The position will benefit as time moves on so long as the underlying shares price moves closer to the strike price you selected.

Despite the fact that this position is a directional trade, It is a calendar or time spread all the same. This is because the strike prices of the short call (sold in the near term) and the long call (purchased at a later expiration) must be the same. The sale of the short-term call will partially offset the cost of the longer term call.

You will break-even in this position when the amount of debit you spent on the difference between the short near-term call and the long-term call is recovered. If you trade this type of setup, you want the short call to expire with less value than the long call. You achieve this as the stock moves closer to the strike price you selected.

Ideally, the setup looks to take advantage of gradual or sharp price swing to the strike price of each of the calls.  This will create the maximum profit.  We are also helped by expanding volatility, which is difficult to achieve in unison with the stock moving upwards.  This is because implied volatility usually decreases as the stock increases in value.

There are two points in time where the maximum profit can be defined:

1. The maximum potential profit at the expiration of the short call would be if the stock was $0.01 below the strike price.  This would cause the short call to expire worthless and you could then sell the remaining value in the long call.
2. The second point to consider is at the expiration of the long call.  Provided that the short call had already expired worthless, then you have “unlimited” profit potential from the long call continuing to rise in value.

There is a problem here, if we consider the second expiration as the maximum profit then we need to recognize that the position is no longer a calendar spread after the expiration of the short call.  Rather, we’d consider that the position was converted into a long call.

For this reason, we always define the maximum profit in the Brutus Options Ranker as the profit potential at the short call’s expiration date.

The maximum potential loss from this position is the net premium paid when the trade was established. Like all long calendar spreads, these positions are considered defined-risk trades.

The broker will debit your account when you enter the position.  As your maximum loss is defined by the debit paid at trade entry, the broker will not require any additional margin requirement to hold this position.

The position will benefit from time-decay so long as the underlying is sufficiently close to the strike price you selected.  If you picked a strike that is very far out of the money and the stock doesn’t move in your favor, then you will see losses with time.

All long calendar spreads benefit from expanding volatility.  Many traders look to long calendar spreads (either in the money or out of the money) during times of sustained low volatility.

An out the money calendar spread is very attractive in place of a long call position. The position uses the near-term short call to pay some of the cost of the long call. The position is often compared against call debit spreads and can offer more attractive risk/reward while taking advantage (in the right pricing zones) of time and volatility expansion.

Key advantages include:

1. A premium offset (cost reduction) for the long call position.
2. A movement downward in the price will increase the IV, making recovery of the net debit easier through a natural hedge.
   
3. Upward movement of the stock’s price after the expiration of the short call will work in favor of the long call.