Horizontal Proliferation

What is a horizontal spread’

Horizontal spread options strategy or futures are created with both long and short positions in derivatives on the same underlying asset, and options, the same strike but different expiration months. The goal is to profit from changes in volatility over time or perceived to exploit temporary deviations in prices due to short-term events.

Also called calendar spread, time spread inter-delivery spread or inside the market spread.

The destruction of horizontal proliferation’

As horizontal spreads, and more popularly known as calendar spreads, are widely used in the futures market, the most part is focused on the analysis of the options market in which a change of volatility is crucial for pricing. The following considers the long spreads, which aim to profit from increasing volatility over time. Short spreads are generated in the opposite configuration, and seeking to profit from declining volatility.

Since the goal for a long scatter in the profits time and volatility, the strike price needs to be as close as possible to the price of the underlying asset. To trade using near-term and long-term law from the cases when time and changing volatility. An increase in implied volatility, ceteris paribus, could have a positive impact on this strategy, because longer-term options are more sensitive to changes in volatility (VEGA above). The caveat is that the two options can, and probably will trade at different implied volatility.

Over time, other things being equal, would have a positive impact on this strategy in early trade to a short-term option. After this strategy is a long conversation, which destroys value over time. Overall, the option value from time decay (theta) increases as its expiration nears.

 

Typical to trade options is the sale of an option (Call or put) with a short term expiration and the simultaneous purchase of a call option (Call or put) with a longer shelf life. Both have the same type and use the same strike.

  • To sell short term put/call
  • Buy long-term put/call
  • Preferably, but not necessarily that implied volatility is low

Again, a short horizontal spread is the opposite with long short-term option and short a longer-term option. Preferably, but not necessarily that implied volatility is higher.

An example of a calendar spread

With Exxon Mobil stock is trading at $89.05 in mid-January 2018:

  • Sell 89 February for $0.97 ($970 per contract)
  • Buy 89 March call for $2.22 ($2,220 per contract)

The cost (debit) the $1.25($1,250 per contract)

As this is a debit spread, the maximum loss is the amount paid for the strategy. The sold option is closer to expiration and thus has a lower price than the option bought, yielding a net debit or cost. Short horizontal spread credit spread i.e. the trader receives money in the early trade.

The perfect market for profit will be stable, only slightly decreasing the price of the underlying asset during the term of the short option followed by a strong upward movement during the life of the future, or sharp upward movement in implied volatility.

Initially strategy is market-neutral or slightly bearish, but after a short the option becomes bullish strategy.

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