Neutral Calendar Call in Stock Markets in India

What Is a Neutral Calendar Call?

A Calendar Call Option is a call option that has been modified on its expiry date by using two different strike prices and two different expiration dates. The option derives its name from the use of two different expiration dates. Usually, when a trader buys an option, he gets the right to exercise it on the expiration day itself. Still, with this type of option, they can exercise their rights either on the first expiry date or on the second expiry date, whichever suits them better.

The key to the calendar call is that the short-term option expires before the long-term one does. The goal of this strategy is for the long-term option to appreciate faster than the short-term option depreciates, producing a net profit.

Detailed Overview of a Neutral Calendar Call

A calendar call spread is a strategy in options trading that involves buying and selling two options of the same type (put or call) on the same underlying stock over the same expiration date. A calendar call spread is also known as a time spread. The term 'calendar' refers to a fixed period within which the strategy is executed, i.e., the expiration date of both the options. In using this strategy, an investor takes up long and short positions.

• A long position involves buying an at-the-money (ATM) option with a higher premium and selling an out-of-the-money (OTM) option with a lower premium. A combination of these two positions allows investors to create calendar call spreads.
• Short position: This involves writing (selling) an ATM option with a higher premium and simultaneously buying another OTM option with a lower premium.

A calendar Call is an Options Strategy where the trader buys and sells the same number of options of the same underlying, but with different strike prices and different expiry dates. Unlike a regularly covered call option, calendar call option spreads are not hedged. Hence, they are extremely risky and should be used when you are very confident in your market view.

Suppose there is a stock you expect to rise by 2% within a few days. You can buy a Call Option at a strike price 1% higher than the current market price and sell a Call Option at a strike price 2% higher than the current market price. These options will expire on the same day, i.e., a few days. You can achieve this using Call Ratio Backspread or Bull Call Spread or simply by buying one Call Option and selling another Call Option.

Illustration of a Neutral Calendar Call Spread Through an Example

A Calendar Call is a strategy in which the trader simultaneously buys a call option and sells another call option with the same strike price but a different expiry date.

The Strategy of a Neutral Calendar Call

The market movement is highly volatile, and it needs its strategy to take a position in the stock market. One such strategy of the calendar call option is used to earn a profit. This strategy is also known as a calendar spread, time spread and horizontal spread. It involves buying a near-month option and selling a longer-term option with the same strike price. Both options are of the same call or put type.

The calendar call option strategy, also known as the time spread options strategy, is a limited risk, limited profit trading strategy employed when the options trader thinks that the underlying stock will experience little or no volatility in the near term. The buyer of the calendar call option expects no movement in the stock price and wants to earn from time decay.

The key to successful calendar spreads is patience. Because time decay occurs more slowly than other option strategies, it may take weeks or even months for your investment to reach its maximum potential. However, if you collect so much premium upfront when you sell the near-term option (and collect even more if you buy back that option before expiration), you can wait it out if your trade goes against you right away.

Outline of Steps Taken to Execute a Neutral Calendar Call in Stock Markets

If you want to trade calendar calls in India, you can do it in NSE, but you need to be an institutional investor or proprietary trader. If you are not, you can use trading platforms that offer options trading.

There are four steps that you should follow to make a calendar call in stock markets in India:

• Analyse the trends of the market
• Select the strike price
• Choose your order type and expiry date
• Monitor your positions and trade accordingly on expiry day

The following steps will guide you while executing calendar calls in stock markets in India:

• Select a stock and exchange by clicking on the 'Stock' drop-down menu. You will find NSE (National Stock Exchange) and BSE (Bombay Stock Exchange).
• Select an index, a stock, or an F&O (Futures & Options) in the 'Symbol' drop-down menu.
• Specify the number of legs for the strategy and click on 'Add' to create another leg for the strategy. A leg is a period for which you will trade. You can select an expiry date from a drop-down menu or manually enter it if it is not available in the drop-down menu.
• Enter the number of contracts that you wish to trade with and select buy/sell options
• Enter the price at which you want to buy/sell and limit the price
• After entering all of this information, click on 'Preview' to check your order details before entering your trade order. A confirmation window will appear that will give you your order details, including the total premium paid and total margin required for placing this order

Advantages of a Neutral Calendar Call

• Reduction in volatility: The calendar month contracts have been devised to reduce the price volatility, which is generally observed during the last three days of the expiry of an agreement. In the case of near-month contracts, this period is usually characterised by extremely high volatility.
• Better liquidity: The near-month contract in the F&O segment typically has better liquidity than the mid-month and far month contracts. All three months will be available for trading simultaneously. There would be sufficient liquidity in all three contracts on a given day.
• Enhanced flexibility: As all three months (near, mid and far) are listed for trading simultaneously, it provides more flexibility to traders to choose between various maturity periods depending upon their market outlook.

Key Risks Involved in Implementing a Neutral Calendar Call

• Calendar call is a strategy that is currently not allowed in Indian stock markets. Therefore, it would require regulatory approval to implement this strategy.
• The most significant risk associated with a calendar call is that the investor may have to pay the entire premium on the stock option purchased (or the difference between the strike price and the market price of the call option) if the underlying stock does not move up to or above the strike price of the option purchased.
• A calendar call can be a loss-making trade even when the Nifty 50 index rises or remains flat over time. The Nifty 50 index may rise slower than what was anticipated while implementing this strategy.
• There could be losses due to mark-to-market adjustments if the Nifty 50 index goes down significantly during the life of this strategy.
• Suppose an investor executes a calendar call with only one month remaining till the expiry of the options. In that case, they will not be able to benefit from any further increase in volatility beyond that point since there won't be enough time left till the expiry for volatility to revert to its historical mean (if volatility increases significantly).

Summary

Calendar calls or Calendar effects are opportunities created when the price of a stock or other financial instrument moves significantly on an ex-dividend day. The rationale is that the dividend income has led to price appreciation because investors have more funds to invest and bid up the price. It is an efficient way to maintain a strict stop loss and capital gain in the stock market.