The Far Option: An Overview
The far option, to an options trader, is the one with the longest time left until its expiration date in a series called a calendar option spread.
A calendar spread involves buying or selling a number of options with different expiration times. In such a spread, the shorter-dated option is called the near option.
- One strategy used by options trader is the calendar option spread.
- This requires buying or selling options in a series, each with a different expiration date.
- The latest trade is the far option.
Far options can only exist if there is a nearer option. This is why the term is used for spread trades, in which a trader buys or sells a series of contracts with different expiration dates.
Understanding Far Options
With a calendar spread, the trader typically uses the same strike price for the near and far options and buys and sells equal amounts of the two options.
A calendar spread strategy may involve selling May calls and buying October calls on the same stock.
A Bullish Trade Example
In this case, assuming it is March, the October calls would be the far options and the May calls would be the near options. If the two options are similar in their other features, except for the expiration date, then the far option will demand a higher premium.
An options trader who chooses this strategy would be bullish long-term on a stock. But there's a chance that the price won't move much before the first option expires. In that case, the trader gets to keep the premium on this sold option, reducing the cost of the more expensive long-term option. This is a bull calendar spread.
A Bearish Trade Example
A bear calendar spread is similar except put options are used. Assume a stock is trading at $50. A trader buys puts that expire in six months with a strike price of $49. This is the far option. The same trader sells, or writes, an equal number of $49 puts that expire in one month.
The options they buy expire in six months, so they demand a higher premium than the options that were sold, which expire in one month.
The calendar option spread allows for a small potential profit even when the stock fails to move as the trader predicts it will.
The goal of the trade is to reduce the cost of the far option by selling the near option, while still being able to take advantage of a decline in the stock's price over the long-term.
The spread takes advantage of time decay, which occurs quicker with options as they draw closer to their expiration date. All else being equal, the premium will deteriorate faster on the near option than on the far one. This allows for a small potential profit even if the stock fails to move as expected.