Morphing a Calendar Spread
Look at the GUC calendar spread (long one July 80 put, short one April 80 put). GUC is at 80.5 and today both puts have an intrinsic value of zero. The July 80 put costs $4.375 and has 73 (trading) days to expiration, and the April 80 put brings you $2.25 and has 10 days to expiration.
To a first approximation, the July 80 put will lose about $0.06 per day in time value and the April 80 put will lose about $0.225 per day in time value, for a net gain of about $0.16 per day between now and the April expiration (less your interest cost for carrying the position, commissions, and other charges, which we will igbore here).
Of course the time decay is not exactly linear and these calculations are rough and can be improved considerably, but they are good enough for a first cut. If nothing changes (which of course never happens, except “on average”), the April 80 put will expire worthless and you will have gained its full premium of $2.25 and the July 80 put will have lost 10 days times $0.06/day, or $0.60. Typically you would close out the spread at that time.
However you might consider another strategy. You would at that time own one July 80 put and have paid $2.06 for it, the cost of the long less the cost of the short. If this cost turns out to be substantially less than the value of the July 80 put at that time, you have then purchased the July 80 put for what may be a pittance.
Assuming it is still undervalued and you can’t sell it for its value in the market, you might consider incorporating it into another spread. You might build a backspread, short some stock, or sell another option against it. If you were a delta neutral trader, you might want to extract the value from the option by dynamic hedging.
These are more complicated strategies and I will be covering them at length in future articles, but the point is that if you have a good toolbox of strategies and can remain flexible, you can “morph” one position into another good position in a fluid way.
Except for a short bond session, the markets are closed tomorrow. Have a nice weekend.