I am from India and trade Nifty options, typically I write next month Call options and spread the strike price. For cover I was thinking about buying same strike price current
month calls.Shall be grateful if you could share your experience on the profitability.
If you buy the current month call (or put) and sell the next
further out call (or put) the resulting position is "short the calendar
Here is what you need to understand:
1. Most investors who trade calendar spreads take the
opposite position. That means they BUY the calendar spread and you
would be SELLING the spread.
2. The fact that most investors do it differently does not make you
wrong, nor does it mean the trade is not a good trade.
3. You did not mention if you are writing in the money, at the money,
or out of the money calls. I'm going to assume you are writing calls
that are at, or near, the money.
4. When you sell the at-the-money calendar spread, your position is net
long gamma and net short vega (volatility). Thus, when the underlying
stock or index makes a LARGE move in either direction, you make money
because the value of the calendar spread decreases as the underlying
moves away from the strike price. However, if the large move is to
the downside, then there is a good chance that the implied volatility
of the longer-term option will increase enough to offset all, or part,
of the profit. That's the result of being short vega. Thus, a large
move in the underlying price would be good for the position, but an up
move is almost always better than a down move.
5. When you sell the ATM calendar spread, if the market trades in a
narrow range as time passes, you lose money. The value of this spread
increases every day when the underlying remains near the strike price
of your calendar spread.
6. Conclusion: This is one way to hedge your short call option, but it
is seldom chosen because it REQUIRES a substantial market move to
generate a profit. I'm not suggesting that you buy the calendar
spread, but most investors prefer (I am NOT one of them) to buy the
spread, hoping the passage of time will produce a profit.
Mark D. Wolfinger
The Rookie's Guide to Options:
The Beginner's Handbook of Trading Equity Options