Study Notes for CFA® Level III – He ...
Reading 27: Hedge Fund Strategies Los 27 a: Discuss how hedge fund strategies... Read More
Calendar spreads involve buying and selling options simultaneously. They are used to express a view on volatility or price direction within a specific timeframe.
An investor is bullish on CBA stock. They want to use call options but expect the shares to increase in value only after the next earnings announcement in two months. In early September, the investor observed the following options prices on the options chain:
$$ \textbf{CBA – Calls (November Expiration)} \\
\begin{array}{c|c}
\textbf{Strike} & \text{Price} \\ \hline
135 & \$4.20 \\ \hline
136 & \$3.50 \\ \hline
137 & \$2.81
\end{array} \\
\textbf{CBA – Calls (December Expiration)} \\
\begin{array}{c|c}
\textbf{Strike} & \text{Price} \\ \hline
135 & \$4.75 \\ \hline
136 & \$4.25 \\ \hline
137 & \$3.65
\end{array} $$
The investor’s objective is to own the December calls anticipating the stock’s increase during the earnings announcement. Instead of directly purchasing the December call, the investor sells a November expiration call to offset the cost.
After careful consideration, the investor buys the 137-strike call in December. This call has a cost of $3.65. However, by transforming it into a calendar spread, the investor sells a 137-strike call expiring in November for $2.81. Therefore, the total cost incurred by the investor is:
$$ -\$3.65 + \$2.81 = -\$0.84 $$
The investor hopes the stock won’t rise above the short strike before November but will increase in December. The breakeven price of the long call is reduced by the proceeds from selling the short strike.
$$ \text{Value of calendar spread} = \text{Long option value} – \text{short option value} $$
Investors who hold a bearish view can also take advantage of calendar spreads. Instead of going long on a calendar spread, they can go short on a calendar spread. This involves selling the long-dated option and buying the near-term option. The goal is to benefit from earlier price movements and potentially close the trade for a profit before expiration. Alternatively, if the favorable price movement reverses or subsides, the long-dated short option could become worthless at expiration.
Calendar spreads can be created using either calls or puts. This allows investors to express a wide range of market views, from bullish to bearish, with different expectations for changes in movement over time.
Question
In January of 20XX, an investor holds a put option on FAbo Corporation (Ticker: FAB), expiring in March of the same year. The investor also sells a put option expiring at the end of January. This newly created position is correctly known as:
- Long calendar call spread.
- Long calendar put spread.
- Short calendar put spread.
Solution
The correct answer is B.
In a long calendar spread, the investor sells the near-term put option and buys the longer-dated put option, which aligns with the scenario described in the question.
A is incorrect. The option is created from a put option but not a call option.
C is incorrect. A short calendar spread is created by purchasing the near-term option and selling the long-dated option. You are essentially selling more time than buying; hence, you are “short the calendar.”
Reading 17: Options Strategies
Los 17 (g) Describe uses of calendar spreads