Time Spreads, also known as Calendar Spreads, are an ideal way
to take advantage of time decay and changes in implied volatility.
The time spread strategy focuses on the movement of time and
volatility more than on the movement of futures and options
Therefore, this strategy is ideal for use when you anticipate
either stagnant or explosive periods in futures and options.
The time spread, like other spreads, has its risks and rewards
for futures and options. The risk is very limited for the buyer,
but substantial for the seller. The sellers risk can be avoided
or contained with due diligence at the expiration of the near
months option. Also, there are a variety of strategies that
can affect the sellers risk.
The advantage of this strategy is that the investor can pursue
a time decay or volatility position without the large capital
outlay necessary for the purchase of futures and options.
Construction Of The Time Spread For Futures And Options
The construction of the time spread involves the purchase of
one option and the sale of another in different months, but
with both having the same strike. You can construct a time spread
using either two calls or two puts.
A long time spread is constructed by purchasing the out month
futures and options and selling the nearer month futures and
options. For example, you buy the September 45 call and sell
the August 45 call or buy April 30 puts and sell February 30
puts. A short time spread is constructed by selling the farther
out month and buying the nearer month. For instance, sell July
50 calls and buy May 50 calls.
The important elements in the construction of the time spread
are: use two call or two put options on the same stock, use
the same strike for both, choose different months for each and
use a one to one ratio. A one to one ratio means that you must
purchase one option for every one you sell or sell one option
for every one you buy. A time spread can utilize any two months
as long as it has the same strike price and the trade is done
in a one-to-one ratio.