The Horizontal Spread Strategy

The horizontal spread is one of many options strategies. However, few strategies are able to take advantage of the discrepancies of the time value in options. The horizontal spread strategy, also known as a calendar spread, is best for capturing an obvious discrepancy of an expiration month's average options price.

Here's an example with July and September expiration months. Say the volatility in the market is 20% and the options for July and September are implying a 18% and 22% volatility, respectively. First, knowing that implied volatility should be at or near 20%, the September options are relatively more expensive than July's expiration. However, there is still more time value for September, so that is not a clear signal to write September options and buy July options.

Using the common analytical calculations, theta is examined.  Theta is the price sensitivity of the option per lapsing day. If theta for July strike priced option is much greater than September's option that means that someone could sell July strike priced option and buy September strike priced option for a short term horizontal spread.

 

blog comments powered by Disqus
Scottrade