Definition of Horizontal Spread§
A Horizontal Spread, often referred to as a Calendar Spread, involves simultaneously going long and short on the same underlying asset with identical strike prices but with different expiration dates. This strategy is particularly popular among traders looking to minimize the effects of time decay, seeking to exploit the fluctuations in the market price of the underlying asset over differing time horizons.
🎉 Humorous Take:§
Why did the trader bring a calendar to his trading session? Because he wanted to spread the risk—at least on different months!
Horizontal Spread vs. Vertical Spread§
| Feature | Horizontal Spread | Vertical Spread |
|---|---|---|
| Expiration Dates | Different | Same |
| Strike Prices | Same | Different |
| Time Decay Impact | Aims to minimize effects | Not a primary focus |
| Market Movements | Relies on varying prices over time | Amplifies price movement |
Examples of Horizontal Spreads§
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Options Example: Purchase a call option on stock (XYZ) with a strike price of $50, expiring in 3 months (long) and simultaneously sell a call option with the same strike price of $50 expiring in 1 month (short). You can profit from time decay while waiting for the stock price to move closer to the expiration month’s expiry.
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Futures Example: Buy a futures contract for crude oil for delivery in March while simultaneously selling a contract for delivery in January. The expectation could be the price difference behavior from January to March.
Related Terms§
- Time Decay: The reduction in the value of options as they approach expiration.
- Strike Price: The preset price at which the holder can buy or sell the underlying asset.
- Long Position: Purchasing options or futures contracts expecting a price gain.
- Short Position: Selling options or futures contracts expecting a price drop.
Formula for Horizontal Spread§
Oh! There’s some excitement in calculating spreads! To model a basic perspective of your profit/loss from a Horizontal Spread, you might consider the following:
Humorous Quote:§
“I wish I were as thin as my portfolio after a bad trade.”
Frequently Asked Questions (FAQs)§
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What is the main objective of using a horizontal spread?
- The primary goal is to take advantage of the time value of options while minimizing the impact of time decay.
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Can horizontal spreads be used in both options and futures trading?
- Yes, horizontal spreads can be effectively utilized in both options and futures markets.
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What risks are involved with horizontal spreads?
- The primary risks involve price movements contrary to what the trader predicts, particularly for the near-term short leg of the spread. Plus, time decay may not work in your favor if you are deeply out of the money.
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When should I consider a horizontal spread?
- When you expect limited movement in the underlying asset’s price and want to benefit from changes in implied volatility over differing expiration dates.
Resources for Further Studies§
- Books:
- Options as a Strategic Investment by Lawrence G. McMillan
- Trading Options For Dummies by Joe Duarte
- Online Resources:
Test Your Knowledge: Horizontal Spread Challenge!§
Thank you for exploring the world of Horizontal Spreads with us! Remember, in trading, as in life, it’s all about timing—just ask a comedian! Keep spreading the knowledge! 💡💰
