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How To Trade A Bull Calendar Spread

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Warning: Bull Calendar Spread is a slightly complex strategy. This should be traded by an experienced trader only. Involves some calculations and knowledge.

Lets explore.

This is a bullish strategy. However a trader may not take huge losses even if he was wrong as this strategy involves hedging right from the second the trade begins. I love hedging by the way. Far better than taking a stop loss where you have to keep an eye in the market every time its opened and till it is closed. Tension hover over your head if your positions are not hedged and naked. True you can put a stop loss in the system in the morning itself but you got to do it every time the market opens if its a positional trade.

I always do positional trades. I hate intraday trading. You can’t make a million bucks trading intraday. Kudos to those who are making money playing intraday. But I know they are few and profits are limited or small. And I don’t want to make money that way.

Ok back to Bull Calendar Spread.

Do you know about debit or credit spreads? If not these spreads are hedged where the trader sells one option and buys another for a debit or a credit of the same underlying and for same expiry but different strike prices depending on their view. The position therefore is properly hedged.

Bull Calendar spreads are not very different from spreads but they involved much more understanding. If you can understand, than calendar spreads are better in terms of rewards than debit or credit spreads. The major difference being it has limited risk but unlimited rewards. If you can recall debit or credit spreads have limited risk and limited rewards.

How to Trade a Bull Calendar Spread?

This is bullish strategy. Lets suppose Nifty is at 6000 and you are expecting a move up. But you do not want to take a naked risk, and want to properly hedge your position you can enter into a bull calendar spread.

What will you do?

Sell to open ATM or OTM near month calls – Strike XXX*. (Sold to decrease buying price of next month calls.)
Buy to open ATM or OTM next month calls – Strike XXX*. (Calls gets cheaper because we sold the same number of calls of the near month.)

*Strike XXX means same strike in both the legs.

Let me take an example.

On Feb-13, 2014 Nifty closed exactly at 6000. Closing prices: Nifty FEB 6000 CE was at 78. Nifty MARCH 6000 CE was at 155.

Lets do the bull calendar spread trade:

Sell to open 2 lots of Nifty FEB 6000 CE: 78*50*2 = Rs. 7800.00 Credit
Buy to open 2 lots of Nifty MARCH 6000 CE: 155*50*2 = Rs. 15,500.00 Debit.

Total debit: 7800 -15500 = Rs. -7700.00

This is the traders’ maximum loss. Now whatever happens, even if Nifty gaps down 5%, the trader will lose less than Rs. 7,700.00. This is the limited loss.

Note that less than 7,700 is important we will discuss it later. Which also means that 7700 is NOT his max loss, its much less than that if the trader chooses to close both calls at the same time. If he carries it forward to the next month and waits till expiry then maybe his max loss would be 7700. More later.

Can you sense that risk reward ratio is extremely good in Bull Calendar Spread? If you still do not understand, do not worry, we will discuss it later in this article.

A loss example here is not required as you know that in any case had the trader not sold the near month calls his lost would have been max at 15,500 i.e. the cost to buy the next month calls. He however reduced the risk by selling the near month calls. So he now knows his max loss.

Lets first calculate the possible profits if Nifty starts moving up.

Nifty starts moving up and expires in FEBRUARY at 6200. 200 points up from 6000.

The following is an assumption of the values of the options. The real results may vary.

The Nifty FEB 6000 CE will be: 200
The Nifty MARCH 6000 CE will be around 335. (Its just an assumption, real rates may vary) .

Calculations:

Loss from Nifty FEB 6000 CE: (78-200) * 50 * 2 = -12200
Profit from Nifty MARCH 6000 CE: (335-155) * 50 * 2 = 18000

Total Profit: 18000-12200 = Rs. 5800.00

ROI:

(5800/60000) * 100 = 9.66% or more in less than 60 days.

Warning: Do Not trade this on the basis of what is written here. There is more to a bull calendar trade than what is written here. Its an advanced strategy done by professionals.

Now I had said that 7700 is not his max loss. Why? Because if the trader does not wait till expiry if Nifty starts to move down, and closes both the trades then he losses some from the next month calls, but he makes profit from the near month calls. Note that this was sold as a hedge. Calculations are not possible because we don’t know the exact values of the calls but its only fair to say that in this case the loss will be much less than 7700. The earlier he closes, the lesser the losses.

In fact a bull calendar spread does better if you sell a near OTM call and buy far months OTM (and not ATM as mentioned in this article.)

Why OTM? Because at the time of expiry if the near month OTM expires worthless, the trader keeps the premium but do not sell the next month OTM at the same time to make a larger unlimited profits. So to make profits from both the calls a trader needs perfect timing. The near month calls expire worthless, and the next month calls kept to play unlimited profits.

Can you do this? If you are highly experienced it may be possible but for not much experienced trader it is better to do a credit spread than a calendar spread.

For a bull calendar to be highly successful a trader needs to have a medium term vision of 40-60 days. For example if Nifty is at 6000 and you feel that it will not cross 6200 this month but may cross 6200 and go up to 6300 or above next month, a bull calendar spread done with OTM calls of 6200 will work great. If it works you will be delighted because you make profits from the hedge and the trade, a very rare situation in trading. Therefore in the long run this trade will lose more than it makes and so I do not recommend that you attempt it.

Look at the risk reward: A trader risks less than he pays to buy calls to make unlimited profits. Though agreed unlimited profits comes with a little more risk. But it has a much better risk reward than a naked call buy. Yes if you were right, a naked call will bring more profits than a bull calendar spread, but that’s the trade off.

Even professionals try a bull calendar spread only occasionally and its not their primary method of trading.

Note that there is another trade similar to this and that is a normal “calendar spread”. Again this trade is complex too. We will discuss it later in this blog, but for those who are interested a normal calendar spread is exact opposite of the bull calendar spread.

Here a trader sells a far month option, and buys a near month option. The near month option acts as a hedging tool for the unlimited loss in the next month options and therefore this trade should be closed as soon as the near month options expires. This trade makes profit if the underlying does not move much and the option sold (far month) declines more in value than the near month options. The trader’s profit is the difference. Unlike the bull calendar, in this trade at least one leg will make a loss. Both legs will never make a profit.

Advance trader adjusts an open trade to make it like a calendar trade, as it is a great hedging tool. For example you bought a Nifty 6000 near month call but you see that Nifty is falling, to limit risk you can immediately sell the next month 6000 call to make the trade a calendar spread. If Nifty keeps falling, you make money.

If its confusing don’t worry, we will discuss calendar spreads later in details.

Similarly a bull calendar spread can also be initiated later in a trade. For example you sold the near month 6000 call in the hope nifty will fall, but your view was wrong and Nifty starts to go up. You can then immediately buy the next month’s 6000 call to make it a bull calendar spread. If nifty keeps going up, you can profit.

Interestingly here if there is a huge resistance, you can sell the next months calls for a profit and hope that nifty reverses. If it does and again goes below 6000, you can profit from both legs.

Frankly its easier said than done. In real world taking such decisions will be really hard. But I wanted to share this knowledge with you.

I hope the bull calendar spread is clear. If you still have questions please ask in the comments section.


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About the author: I started trading stock markets since 2007. However my first 3 years were losses. Then I dedicated almost 1 year on studying, researching, paper trading options and learned a lot in that time. Since 2011 I am trading Nifty options profitably. Call me if you need any help trading options on 9051143004.

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