Time spread
| Range | Value |
|---|---|
Market expectation | Unchanged exchange rates |
Construction | Call short with a shorter term |
Profit potential | Limited |
Risk of loss | Limited |
Time effect | Positive |
Volatility effect | (Slightly) Positive |
Market expectation
If you assume unchanged prices, it is possible to speculate on the different performance of warrants with different remaining terms with the help of a time spread.
Construction
A time spread consists of a bought and a sold option of the same option class with identical strike prices but different remaining terms.
In order to benefit from the greater loss of time value of the option with a shorter term, it is sold. The identical option with a longer term is purchased.
This applies to time spreads with calls as well as those with puts.
The aim is for the option to expire with a shorter term, so the options should be selected in line with market expectations:
- Bear time spread: If you expect prices to fall, choose a warrant strike price below the current price of the underlying.
- Neutral time spread: If you do not expect any price changes, select the strike price at the level of the current price.
- Bull time spread: If you expect prices to rise, choose a higher strike price than the current price.
Profit potential
The profit potential is limited. The closer the price of the underlying is to the strike price at the end of the term of the short position, the higher the profit. If it is quoted exactly at the strike price, it is at its maximum. The option expires and the one with a longer term is "at-the-money" with maximum time value. This current value minus the difference in premiums (paid) gives the maximum profit.
Risk of loss
The risk of loss is limited. The intrinsic values cancel each other out, so the maximum loss is the (paid) difference in premiums, which is always incurred because the option with the longer term is always bought and this is more expensive due to the higher time value.
Time effect
The positive time value effect is the advantage of a time spread. The option with a shorter term and therefore a faster time value expiry is sold, on balance you benefit from this effect.
A negative time effect can only arise if the price moves contrary to expectations, but this can be prevented by opting for bull or bear time spreads.
Volatility effect
The volatility effect of the overall position is largely neutral, but as the purchased option has a longer term, it is more strongly influenced by changes in volatility. This creates a slightly positive effect.