What is a Far Option
The far option is the option with the longer time to expiration in a calendar option spread. A calendar spread involves buying or selling options with different expirations. In such a spread, the shorter-dated option is the near option. Because far options have more time to move in-the-money, they are associated with larger premiums than similar near options.
Breaking Down the Far Option
Far options only exist if there is a nearer option. This is why the term is used for spread trades, where a trader is buying or selling different contracts with different expiration dates.
Far Options in Spreads
A calendar spread strategy may involve selling May calls and buying October calls on the same stock. 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.
A trader would do this sort of trade if they are long-term bullish on a stock, but feel it may not move before the first option expires. If the price doesn't move much before the first option expires then they get to keep the premium on this sold option, which reduces the cost of the more expensive long-term option they bought. This is a bull calendar spread.
With a calendar spread, the trader typically uses the same strike price for the near and far options, and also buys and sells equal amounts of the two options.
A bear calendar spread is similar, except uses put options. 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. They sell, or write, 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 they sold which expire in one month. 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 closer to expiry. All else being equal, the premium will deteriorate quicker on the near option than on the far one. This provides for a small potential profit margin, even if the stock doesn't move as expected.