Can someone explain reverse calendar spread with e.g?
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A reverse calendar spread is an options trading strategy that involves selling a near-term option and buying a longer-term option of the same type (either both calls or both puts) with a lower strike price. This strategy profits from the difference in time decay between the two options and the potential increase in volatility in the underlying asset.
Here’s an example of a reverse calendar spread using call options:
Let’s assume that you have a bullish outlook on a stock, which is currently trading at $100. You want to implement a reverse calendar spread to potentially profit from an increase in the stock’s price over time.
Step 1: Sell a near-term call option
You sell a call option with a strike price of $105 expiring in one month for a premium of $2. This call option will have a higher time decay rate than the longer-term option you will buy in the next step.
Step 2: Buy a longer-term call option
You buy a call option with a strike price of $100 expiring in three months for a premium of $4. This call option will have a lower time decay rate than the near-term option you sold in the first step.
Your net cost for the reverse calendar spread is $2 ($4 premium for the longer-term call option minus the $2 premium received from the sale of the near-term call option).
Scenario 1: Stock price remains below $105 at expiration
If the stock price remains below the $105 strike price of the near-term call option at expiration, the option will expire worthless and you will keep the $2 premium received from its sale. The longer-term call option will still have value and you can sell it or hold it for further price appreciation.
Scenario 2: Stock price increases above $105 at expiration
If the stock price increases above the $105 strike price of the near-term call option at expiration, the option you sold will be exercised and you will be obligated to sell the stock at $105. However, since you bought the longer-term call option with a strike price of $100, you can exercise that option to buy the stock back at $100 and then sell it at $105, realizing a $5 profit ($105 sale price – $100 purchase price – $2 premium received = $3 profit per share).
Overall, a reverse calendar spread is a flexible strategy that can be used in a variety of market conditions. However, it does involve some risks, including the potential for losses if the stock price remains stagnant or declines. Therefore, it’s important to carefully evaluate the risks and rewards of this strategy before implementing it.
The answer which you have given is of the calendar spread. Moreover in the reverse calendar spread there is a bearish outlook not bullish. Also when we do the calendar spread or reverse calendar spread we take different maturity with the same stock at the same strike price. But here in your answer the strike price are also different.
Sir can you please help me in this?