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Chapter 8 Neutral Option Strategies

Neutral Option Strategies

Neutral Option Strategy is made use of when the trader expects the volatility in the market to decline after a sharp spike. The trader expects the stock to trade in a narrow range and expects the option premium of call and put options to decline. Following are the most popular strategies that can be used when the market is expected to trade range bound with a decline in volatility.

How to make Profit in a Sideways Market: Short Strangle strategy

How to make Profit in a Sideways Market: Short Strangle strategy

A Short Strangle strategy consists of one short call with higher strike price and one short put with lower strike price. It is established for a net credit and generates profit only when the underlying stock expires between two strikes sold. Every day that passes without large movement in the underlying assets will benefit this strategy due to time erosion. Volatility is a vital factor and it can adversely affect a trader’s profits in case it goes up.

When to initiate a Short Strangle strategy?

A Short Strangle strategy should only be used when you are very confident that the security won’t move in either direction because the potential loss can be substantial if that happens. This strategy can also be used by advanced traders when the implied volatility goes abnormally high and the call and put premiums may be overvalued. After initiating Short Strangle, the idea is to wait for implied volatility to drop and close the position at a profit. Inversely, this strategy can lead to losses in case the implied volatility rises even if the stock price remains at same level.

How to construct a Short Strangle strategy?

A Short Strangle strategy is implemented by selling Out-the-Money Call option and simultaneously selling Out-the-Money Put option of the same underlying security with the same expiry. Strike price can be customized as per convenience of the trader but the call and put strikes must be equidistant from the spot price.

Strategy Sell OTM Call and Sell OTM Put
Market Outlook Neutral or very little volatility
Motive Earn income from selling option premium
Upper Breakeven Strike price of short call + Net Premium received
Lower Breakeven Strike price of short put - Net Premium received
Risk Unlimited
Reward Limited to Net Premium received (when underlying assets expires in the range of call and put strikes sold)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price Rs 8800
Sell OTM Call Strike Price Rs 9000
Premium Received (per share) Rs 40
Sell OTM Put Strike price Rs 8600
Premium Received (per share) Rs 30
Upper breakeven 9070
Lower breakeven 8530
Lot Size 75

Suppose Nifty is trading at 8800. An investor, Mr A is expecting very little movement in the market, so he enters a Short Strangle by selling 9000 call strike at Rs.40 and 8800 put for Rs.30. The net upfront premium received to initiate this trade is Rs.70, which is also the maximum possible reward. Since this strategy is initiated with a view of no movement in the underlying security, the loss can be substantial when there is significant movement in the underlying security. The maximum profit will be limited to the upfront premium received, which is around Rs.5250 (70*75) in the example cited above. Another way by which this strategy can be profitable is when the implied volatility falls.

For the ease of understanding, we did not take into account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff Chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from Call Buy (Rs) Net Payoff from Put Buy (Rs) Net Payoff (Rs)
8300 40 -270 -230
8400 40 -170 -130
8500 40 -70 -30
8530 40 -40 0
8600 40 30 70
8700 40 30 70
8800 40 30 70
8900 40 30 70
9000 40 30 70
9070 -30 30 0
9100 -60 30 -30
9200 -160 30 -130
9300 -260 30 -230

Impact of option Greeks:

Delta: A Short Strangle has near-zero delta. Delta estimates how much an option price will change as the stock price changes. When the stock price trades between the upper and lower wings of Short Strangle, call Delta will drop towards zero and put Delta will rise towards zero as the expiration date draws nearer.

Vega: A Short Strangle has a negative Vega. This means all other things remain the same, increase in implied volatility will have a negative impact.

Theta: With the passage of time, all other things remain same, Theta will have a positive impact on the strategy, because option premium will erode as the expiration dates draws nearer.

Gamma: Gamma estimates how much the Delta of a position changes as the stock prices changes. Gamma of the Short Strangle position will be negative as we are short on options and any major movement on either side will affect the profitability of the strategy.

How to manage risk?

Since this strategy is exposed to unlimited risk, it is advisable not to carry overnight positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.

Analysis of Short Strangle strategy:

A Short Strangle strategy is the combination of short call and short put and it mainly profits from Theta i.e. time decay factor if the price of the security remains relatively stable. This strategy is not recommended for amateur/beginner traders, because the potential losses can be substantial and it requires advanced knowledge of trading.

How to make Profit in a Neutral Market: Short Straddle Option Strategy

A Short Straddle strategy is a race between time decay and volatility. Every day that passes without movement in the underlying assets will benefit this strategy from time erosion. Volatility is a vital factor and it can adversely affect a trader’s profits in case it goes up.

When to initiate a Short Straddle Options Trading Strategy?

A short options trading straddle strategy can be used when you are very confident that the security won’t move in either direction because the potential loss can be substantial if that happens. This strategy can also be used by advanced traders when the implied volatility goes abnormally high for no obvious reason and the call and put premiums may be overvalued. After selling straddle, the idea is to wait for implied volatility to drop and close the position at a profit. Inversely, this strategy can lead to losses in case the implied volatility rises even if the stock price remains at same level.

How to Construct a Short Straddle Options Trading Strategy?

A short straddle is implemented by selling at-the-money call and put option of the same underlying security with the same expiry.

Strategy Sell ATM Call and Sell ATM Put
Market Outlook Neutral or very little volatility
Motivation Earn income from selling option premium
Upper Breakeven Strike price of short call + Net Premium received
Lower Breakeven Strike price of short put - Net Premium received
Risk Unlimited
Reward Limited to Net Premium received (when underlying assets expires exactly at the strikes price sold)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price Rs.8800
Sell ATM Call & Put(Strike Price) Rs.8800
Premium received (per share) Call Rs.80
Put Rs.90
Upper breakeven Rs.8970
Lower breakeven Rs.8630
Lot Size(in units) 75

Suppose, Nifty is trading at 8800. An investor, Mr. A is expecting no significant movement in the market, so he enters a Short Straddle by selling a FEB 8800 call strike at Rs.80 and FEB 8800 put for Rs.90. The net upfront premium received to initiate this trade is Rs.170, which is also the maximum possible reward. Since this strategy is initiated with a view of no movement in the underlying security, the loss can be substantial when there is significant movement in the underlying security. The maximum profit will be limited to the upfront premium received, which is around Rs.12750 (170*75) in the example cited above. Another way by which this strategy can be profitable is when the implied volatility falls.

For the ease of understanding, we did not take into account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff Chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from Call Sell (Rs) Net Payoff from Put Sell (Rs) Net Payoff (Rs)
8300 80 -410 -330
8400 80 -310 -230
8500 80 -210 -130
8600 80 -110 -30
8630 80 -80 -0
8700 80 10 70
8800 80 90 170
8900 -20 90 70
8970 -90 90 0
9000 -120 90 -30
9100 -220 90 -130
9200 -320 90 -230
9300 -420 90 -330

Impact of Options Greeks:

Delta: Since we are initiating ATM options position, the Delta of call and put would be around 0.50.

  • 8800 CE Delta @ 0.5, since we are short, the delta would be -0.5.
  • 8800 PE Delta @-0.5, since we are short, the delta would be +0.5.
  • Combined delta would be -0.5+0.5=0.

Delta neutral in case of Short Straddle suggests profit is capped. If the underlying assets move significantly, the losses would be substantial.

Gamma: Gamma of the overall position would be Negative.

Vega: Short Straddle Strategy has a negative Vega. Therefore, one should initiate Short Straddle only when the volatility is high and expects to fall.

Theta: Time decay is the sole beneficiary for the Short Straddle trader given that other things remain constant. It is most effective when the underlying price expires around ATM strike price.

How to manage risk?

Since this strategy is exposed to unlimited risk, it is advisable not to carry overnight positions. Also, one should always strictly adhere to Stop Loss in order to restrict losses.

Analysis of Short Straddle Option Trading Strategy:

A Short Straddle Option Trading Strategy is the combination of short call and short put and it mainly profits from Theta i.e. time decay factor if the price of the security remains relatively stable. This strategy is not recommended for amateur/beginner traders, because the potential losses can be substantial and it requires advanced knowledge of trading.

Long Call Butterfly Options Strategy

A Long Call Butterfly is implemented when the investor is expecting very little or no movement in the underlying assets. The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value with limited risk.

When to initiate a Long Call Butterfly?

A Long Call Butterfly spread should be initiated when you expect the underlying assets to trade in a narrow range as this strategy benefits from time decay factor. However, unlike Short Strangle or Short Straddle, the potential risk in a Long Call Butterfly is limited. Also, when the implied volatility of the underlying assets increases unexpectedly and you expect volatility to come down, then you can apply Long Call Butterfly strategy.

How to construct a Long Call Butterfly?

A Long Call Butterfly can be created by buying 1 ITM call, buying 1 OTM call and selling 2 ATM calls of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be equidistant from the middle strike.

Strategy Buy 1 ITM Call, Sell 2 ATM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction & Bearish on volatility
Upper Breakeven Higher Strike price of buy call - Net Premium Paid
Lower Breakeven Lower Strike price of buy call + Net Premium Paid
Risk Limited to Net Premium Paid
Reward Limited (Maximum profit is achieved when market expires at middle strike)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs) 8800
Buy 1 ITM call of strike price (Rs) 8700
Premium paid (Rs) 210
Sell 2 ATM call of strike price (Rs) 8800
Premium received (Rs) 300 (150*2)
Buy 1 OTM call of strike price (Rs) 8900
Premium paid (Rs) 105
Upper breakeven 8885
Lower breakeven 8715
Lot Size 75
Net Premium Paid (Rs) 15

Suppose Nifty is trading at 8800. An investor Mr A thinks that Nifty will not rise or fall much by expiration, so he enters a Long Call Butterfly by buying a March 8700 call strike price at Rs.210 and March 8900 call for Rs 105 and simultaneously sold 2 ATM call strike price of 8800 @150 each. The net premium paid to initiate this trade is Rs.15, which is also the maximum possible loss. This strategy is initiated with a neutral view on Nifty hence it will give the maximum profit only when there is no movement in the underlying security. Maximum profit from the above example would be Rs.6375 (85*75). The maximum profit would only occur when underlying assets expires at middle strike. Maximum loss will also be limited if it breaks the upper and lower break-even points i.e. Rs.1125 (15*75). Another way by which this strategy can give profit is when there is a decrease in implied volatility.

For the ease of understanding, we did not take in to account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from 1 ITM Call Bought (Rs) Net Payoff from 2 ATM Calls Sold (Rs) Net Payoff from 1 OTM Call Bought (Rs) Net Payoff (Rs)
8200 -210 300 -105 -15
8300 -210 300 -105 -15
8400 -210 300 -105 -15
8500 -210 300 -105 -15
8600 -210 300 -105 -15
8700 -210 300 -105 -15
8715 -195 300 -105 0
8800 -110 300 -105 85
8885 -25 130 -105 0
8900 -10 100 -105 -15
9000 90 -100 -5 -15
9100 190 -300 95 -15
9200 290 -500 195 -15
9300 390 -700 295 -15
9400 490 -900 395 -15

Impact of Options Greeks before expiry:

Delta: The net delta of a Long Call Butterfly spread remains close to zero.

Vega: Long Call Butterfly has a negative Vega. Therefore, one should buy Long Call Butterfly spread when the volatility is high and expect to decline.

Theta: It measures how much time erosion will affect the net premium of the position. A Long Call Butterfly will benefit from theta if it expires at middle strike.

Gamma: This strategy will have a long gamma position.

How to manage Risk?

A Long Call Butterfly is exposed to limited risk, so carrying overnight position is advisable but one can keep stop loss to further limit losses.

Analysis of Long Call Butterfly strategy:

A Long Call Butterfly spread is best to use when you are confident that an underlying security will not move significantly and will stay in a range. Downside risk is limited to net debit paid, and upside reward is also limited but higher than the risk involved.

Short Iron Butterfly Options Strategy

A Short Iron Butterfly strategy is implemented when an investor is expecting very little or no movement in the underlying assets. The motive behind initiating this strategy is to rightly predict the stock price till expiration and gain from time value. It is a limited risk and a limited reward strategy, similar to Long Call Butterfly strategy. A Short Iron Butterfly could also be considered as a combination of Bear Call Spread and Bull Put Spread.

When to initiate a Short Iron Butterfly?

A Short Iron Butterfly spread is best to use when you expect the underlying assets to trade in a narrow range as this strategy benefits from time decay factor. Also, when the implied volatility of the underlying assets increases unexpectedly and you expect volatility to come down, then you can apply Short Iron Butterfly strategy.

How to construct a Short Iron Butterfly?

A Short Iron Butterfly can be created by selling 1 ATM call, buying 1 OTM call, selling 1 ATM put and buying 1 OTM put of the same underlying security with the same expiry. Strike price can be customized as per the convenience of the trader; however, the upper and lower strike must be equidistant from the middle strike.

Strategy Sell 1 ATM Call, Buy 1 OTM Call, Sell 1 ATM Put and Buy 1 OTM Put
Market Outlook Neutral on market direction & Bearish on volatility
Motive Earn from time value with limited risk
Upper Breakeven Short Option (Middle) Strike price + Net Premium Received
Lower Breakeven Short Option (Middle) Strike price - Net Premium Received
Risk Limited
Reward Limited to premium received
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price (Rs) 9200
Sell 1 ATM Call of strike price (Rs) 9200
Premium received (Rs) 70
Buy 1 OTM Call of strike price (Rs) 9300
Premium paid (Rs) 30
Sell 1 ATM Put of strike price (Rs) 9200
Premium received (Rs) 105
Buy 1 OTM Put of strike price (Rs) 9100
Premium paid (Rs) 65
Upper breakeven 9280
Lower breakeven 9120
Lot Size 75
Net Premium Received (Rs) 80

Suppose Nifty is trading at 9200. An investor, Mr. A thinks that Nifty will not rise or fall much by expiration, so he enters a Short Iron Butterfly by selling a 9200 call strike price at Rs.70, buying 9300 call for Rs.30 and simultaneously selling 9200 put for Rs.105, buying 9100 put for Rs.65. The net premium received to initiate this trade is Rs.80, which is also the maximum possible gain. This strategy is initiated with a neutral view on Nifty hence it will give the maximum profit only when the underlying assets expire at middle strike. The maximum profit from the above example would be Rs.6,000 (80*75). The maximum loss will also be limited to Rs.1,500 (20*75), if it breaks the upper and lower break-even points. Another way by which this strategy can give profit is when there is a decrease in implied volatility.

For the ease of understanding, we did not take into account commission charges. Following is the payoff chart and payoff schedule assuming different scenarios of expiry.

The Payoff chart:

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from 1 ITM Call Bought (Rs) 9200 Net Payoff from 1 OTM Call Sold (Rs) 9300 Net Payoff from 1 ATM Put bought (Rs) 9200 Net Payoff from 1 OTM Put sold (Rs.) 9100 Net Payoff (Rs)
8800 70 -30 -295 235 -20
8900 70 -30 -195 135 -20
9000 70 -30 -95 35 -20
9100 70 -30 5 -65 -20
9120 70 -30 25 -65 0
9200 70 -30 105 -65 80
9280 -10 -30 105 -65 0
9300 -30 -30 105 -65 -20
9400 -130 70 105 -65 -20
9500 -230 170 105 -65 -20
9600 -330 270 105 -65 -20

Impact of Options Greeks before expiry:

Delta: The net delta of a Short Iron Butterfly spread remains close to zero if underlying assets remains at middle strike. Delta will move towards -1 if the underlying assets expire above the higher strike price and Delta will move towards 1 if the underlying assets expire below the lower strike price.

Vega: Short Iron Butterfly has a negative Vega. Therefore, one should initiate Short Iron Butterfly spread when the volatility is high and is expected to fall.

Theta: With the passage of time, if other factors remain the same, Theta will have a positive impact on the strategy.

Gamma: This strategy will have a short Gamma position, so the change in underline asset will have a negative impact on the strategy.

How to manage Risk?

A Short Iron Butterfly is exposed to limited risk compared to reward, so carrying overnight position is advisable.

Analysis of Short Iron Butterfly strategy:

A Short Iron Butterfly spread is best to use when you are confident that an underlying security will not move significantly and will stay in a range. Downside risk is limited to the net premium received, and upside reward is also limited but higher than the risk involved. It provides a good reward to risk ratio.

Long Call Condor Options Trading Strategy

Long Call Condor options trading strategy

A Long Call Condor is similar to a Long Butterfly strategy, wherein the only exception is that the difference of two middle strikes sold has separate strikes. The maximum profit from condor strategy may be low as compared to other trading strategies; however, a condor strategy has high probability of making money because of wider profit range.

When to initiate a Long Call Condor

A Long Call Condor spread should be initiated when you expect the underlying assets to trade in a narrow range as this strategy benefits from time decay factor.

How to construct a Long Call Condor?

A Long Call Condor can be created by buying 1 lower ITM call, selling 1 lower middle ITM call, selling 1 higher middle OTM call and buying 1 higher OTM calls of the same underlying security with the same expiry. The ITM and OTM call strikes should be equidistant.

Strategy Buy 1 ITM Call, Sell 1 ITM Call, Sell 1 OTM Call and Buy 1 OTM Call
Market Outlook Neutral on market direction and Bearish on volatility
Motive Anticipating minimal price movement in the underlying assets
Upper Breakeven Higher Strike price - Net Premium Paid
Lower Breakeven Lower Strike price + Net Premium Paid
Ris> Limited to Net premium paid
Reward Limited (Maximum profit is achieved when underlying expires between sold strikes)
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price 9100
Buy 1 deep ITM call of strike price (Rs) 8900
Premium paid (Rs) 240
Sell 1 ITM call of strike price (Rs) 9000
Premium received (Rs) 150
Sell 1 OTM call of strike price (Rs) 9200
Premium received (Rs) 40
Buy 1 deep OTM call of strike price (Rs) 9300
Premium paid (Rs) 10
Upper breakeven 9240
Lower breakeven 8960
Lot size 75
Net premium paid 60

Suppose Nifty is trading at 9100. An investor Mr. A estimates that Nifty will not rise or fall much by expiration, so he enters a Long Call Condor and buys 8900 call strike price at Rs.240, sells 9000 strike price of Rs.150, sells 9200 strike price for Rs 40 and buys 9300 call for Rs.10. The net premium paid to initiate this trade is Rs.60, which is also the maximum possible loss. This strategy is initiated with a neutral view on Nifty hence it will give the maximum profit only when there is little or no movement in the underlying security. Maximum profit from the above example would be Rs.3000 (40*75). The maximum profit would only occur when underlying assets expires in the range of strikes sold.

In the mentioned scenario, maximum loss would be limited up to Rs.4500 (60*75) and it will occur if the underlying assets goes below 8960 or above 9240 strikes at expiration. If the underlying assets expires at the lowest strike then all the options will expire worthless, and the debit paid to initiate the position would be lost. If the underlying assets expire at highest strike, all the options below the highest strike would be In-the-Money. Furthermore, the resulting profit and loss would offset and net premium paid would be lost.

For the ease of understanding of the payoff schedule, we did not take in to account commission charges. Following is the payoff schedule assuming different scenarios of expiry.

The Payoff Schedule:

On Expiry NIFTY closes at Net Payoff from 1 Deep ITM Call bought (Rs) 8900 Net Payoff from 1 ITM Call sold (Rs) 9000 Net Payoff from 1 OTM Call sold (Rs) 9200 Net Payoff from 1 deep OTM call bought (Rs) 9300 Net Payoff (Rs)
8600 -240 150 40 -10 -60
8700 -240 150 40 -10 -60
8800 -240 150 40 -10 -60
8900 -240 150 40 -10 -60
8960 -180 150 40 -10 0
9000 -140 150 40 -10 40
9100 -40 50 40 -10 40
9200 60 -50 40 -10 40
9240 100 -90 0 -10 0
9300 160 -150 -60 -10 -60
9400 260 -250 -160 90 -60
9500 360 -350 -260 190 -60
9600 460 -450 -360 290 -60

The Payoff Graph:

Impact of Options Greeks before expiry:

Delta: If the underlying asset remains between the lowest and highest strike price the net Delta of a Long Call Condor spread remains close to zero.

Vega: Long Call Condor has a negative Vega. Therefore, one should initiate Long Call Condor spread when the volatility is high and expect to decline.

Theta: A Long Call Condor has a net positive Theta, which means strategy will benefit from the erosion of time value.

Gamma: The Gamma of a Long Call Condor strategy goes to lowest values if it stays between sold strikes, and goes higher if it moves away from middle strikes.

Analysis of Long Call Condor spread strategy

A Long Call Condor spread is best to use when you are confident that an underlying security will not move significantly and stays in a range of strikes sold. Long Call Condor has a wider sweet spot than the Long Call Butterfly. But there is a tradeoff; this is a limited reward to risk ratio strategy for advance traders.

Long Call Calendar Spread

A Long Call Calendar Spread is initiated by selling one call option and simultaneously buying a second call option of the same strike price of underlying assets with a different expiry. It is also known as Time Spread or Horizontal Spread. The purpose of this strategy is to gain from Theta with limited risk, as the Time Decay of the near period expiry will be faster as compared to the far period expiry. As the near period option expires, far month call option would still have some premium in it, so the option trader can either own the far period call or square off both the positions at same time on near period expiry.

When to initiate a Long Call Calendar Spread?

A Long Call Calendar Spread can be initiated when you are very confident that the security will remain neutral or bearish in near period and bullish in longer period expiry. This strategy can also be used by advanced traders to make quick returns when the near period implied volatility goes abnormally high as compared to the far period expiry and is expected to cool down. After buying a Long Calendar Spread, the idea is to wait for the implied volatility of near period expiry to drop. Inversely, this strategy can lead to losses in case the implied volatility of near period expiry contract rises even if the stock price remains at same level.

How to construct a Long Call Calendar Spread?

A Long Call Calendar Spread is implemented by selling near month at-the-money/out-the-money call option and simultaneously buying far month at-the-money/out-the-money call option of the same underlying assets.

Strategy Buy far month ATM/OTM call and sell near month ATM/OTM call.
Market Outlook Neutral to positive movement.
Motive Hopes to reduce the cost of buying far month call option.
Risk Limited to the difference between the premiums.
Reward Limited if both the positions squared off at near period expiry. Unlimited if far period call option hold till next expiry.
Margin required Yes

Let’s try to understand with an example:

Nifty Current spot price 9000
Sell near month ATM call strike price Rs. 9000
Premium received (per share) Rs. 180
Buy far month ATM call strike price Rs. 9000
Premium paid (per share) Rs. 250
Lot size (in units) 75

Suppose Nifty is trading at 8800. An investor, Mr. A is expecting no significant movement in near month contract, so he enters a Long Call Calendar Spread by selling near month strike price of 9000 call at Rs.180 and bought 9000 call for Rs.250. The net upfront premium paid to initiate this trade is Rs.70, which is also the maximum possible loss. The idea is to wait for near month call option to expire worthless by squaring off both the positions in near month expiry contract or reduce the cost of far month buy call by setting off the profit made from the near month call option. Another way by which this strategy can be profitable is when the implied volatility of the near month falls.

For the ease of understanding, we did not take into account commission charges. Following is the payoff chart of the expiry.

The Payoff Schedule on near period expiry date:

Near period expiry if NIFTY closes at Net Payoff from near period Call sold (Rs.) Theoretical Payoff from far period call Buy (Rs.) Net Payoff at near period expiry (Rs.)
8700 180 -190 -10
8800 180 -160 20
8900 180 -120 60
9000 180 -70 110
9100 80 -10 70
9200 -20 +60 40
9300 -120 140 20
9400 -220 230 10
9500 -320 330 10

Following is the payoff schedule till far expiry, where maximum loss would be limited up to 320 Rs (250+70), Rs.70 is from near expiry and Rs.250 is the premium of far month call bought. Maximum profit would be unlimited since far month call bought will have unlimited upside potential.

Net Combined Payoff Schedule on next period expiry date:

NIFTY closing price on Near and Far period expiry Theoretical Payoff from far period call Buy (Rs.) Net Payoff at near period expiry (Rs.) Net Payoff at Far period expiry (Rs.)
8700 -250 -10 -260
8800 -250 20 -230
8900 -250 60 -190
9000 -250 110 -140
9100 -150 70 -80
9200 -50 40 -10
9300 50 20 70
9400 150 10 160
9500 250 10 260

The Payoff Graph

Impact of option Greeks:

Delta: The net Delta of a Long Call Calendar will be close to zero or marginally positive. The negative Delta of the near month short call option will be offset by positive Delta of the far month long call option.

Vega: A Long Call Calendar has a positive Vega. Therefore, one should buy spreads when the volatility of far period expiry contract is expected to rise.

Theta: With the passage of time, if other factors remain same, Theta will have a positive impact on the Long Call Calendar Spread in near period contract, because option premium will erode as the near period expiration dates draws nearer.

Gamma: Gamma estimates how much the Delta of a position changes as the stock prices changes. The near month option has a higher Gamma. Gamma of the Long Call Calendar Spread position will be negative till near period expiry, as we are short on near period options and any major upside movement till near period expiry will affect the profitability of the spreads.

How to manage risk?

A Long Call Calendar spread is exposed to limited risk up to the difference between the premiums, so carrying overnight position is advisable but one can keep stop loss on the underlying assets to further limit losses.

Analysis of Long Call Calendar Spread strategy

A Long Call Calendar Spread is the combination of short call and long call option with different expiry. It mainly profits from Theta i.e. Time Decay factor of near period expiry, if the price of the security remains relatively stable in near period. Once the near period option has expired, the strategy becomes simply long call, whose profit potential is unlimited.

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