Example: XYZ stock is trading at $50
Outlook: You are neutral on XYZ stock short term.
Possible strategy: Buy Time Spread to take advantage of short term time decay.
Sell one July 50 strike call $2.50
Buy one August 50 strike call $3.75
Net Debit $1.25
- Maximum Profit = Long call value at near term expiration - Net Debit
- Maximum Loss = Net Debit paid for spread $1.25
IN SUMMARY: This spread will be profitable if XYZ stabilizes to the at-the-money strike at July expiration. Time decay is in your favor because time erosion accelerates as July expiration approaches. Maximum profit depends on the value of the long call at near term expiration. Maximum loss is equal to the debit paid for the spread.