The price of a time spread will fluctuate with movements in
stock price. A time spread will be at its widest when the stock
price and the strike price of the spread are identical (i.e.
at-the-money).
As the stock moves away from the strike in either direction, the
value of the time spread will decrease. As the stock moves in
either direction away from the spreads strike, the closer month
will experience a quicker price change due to the front months
higher gamma.
Gamma shows the rate of change of an options delta in relation
to movements in the price of the stock. It is the delta of the
delta! Gamma is highest in at-the-money options and in the front
month. It decreases as you move away from the at-the-money
strike and as you move out over time.
In the same way that a time spread loses value as the stock
price moves away from the strike price, the opposite is true
also. As the stock price moves closer to the strike price, the
value of the time spread increases.
For example, lets examine the June / July 65 call time spread.
With the stock priced at 65 (directly at the strike) the spread
is at its widest point (highest value). Now, as the stock climbs
away from 65 and pushes toward 70, the June / July 65 spread
loses value.
However, at the same time the June / July 65 loses value, the
June / July 70 spread gains in value as the stock approaches the
70 strike. When the stock reaches 67.50 the point equidistant
(mid-point) between the two strikes, both spreads will be
trading at approximately the same value.
Look at chart 2. Notice that as the stock increases from 57.50,
both the June / July 65 and June / July 70 spreads increase in
value. Their increases continue until they reach their strike
price at which time they both begin to lose value.
This demonstrates that the spread with the strike price that the
stock is moving toward will increase in value while the spread
with the strike price that the stock is moving away from will
simultaneously lose value.
Chart 2 follows the effect of the movement of the stock price
across the two time spreads. |
