A long calendar spread with calls, also known as a time spread, is a position made up of selling a short-term call and buying a long-term call with the same strike price. The idea is that the shorter-term call, with more accelerated time decay losses value more quickly as expiration approaches and will hopefully be worth nothing or close to nothing at expiration, while the longer-term call retains most of its value. By selling the shorter-term call, this reduces the cost of the trade.
The trader wants the stock to trade right up to the strike price, but not over, at the shorter-term call at expiration. Once this option expires worthless, then a single long call is left, allowing for profits if the stock continues to trade higher.
This position has unlimited profit potential, but not until the shorter-term call expires worthless.
If the stock has a sharp move in either direction before the short-term call expires, then the time value of this spread becomes worthless, and the trader will lose his premium paid for the trade.
The long calendar spread with calls has two breakeven points; they both happen if the stock has a sharp move higher or lower before the short-term call expires. However, because the time value of this trade depends on the volatility level, it is impossible to know exactly where these points are.
If stock XYZ is trading $95 and we buy a 100-strike price long calendar call spread that consists of selling a March call for $3 and purchasing a July call for $4.50, then our next cost would be a $1.50 ($4.50-$3).
If the stock trades up to $99 at March expiration, the March calls would expire worthless, and the short March calls would get removed from our account. Now we are left with just the long July calls. If the stock traded up to $110 by July expiration, then we would profit $10 on the calls, but because we paid $1.50 for the position our profit would be $8.50. Consider this as if we only bought the July calls to begin with (not selling March) our profit would have only been $5.50.
If the stock traded down to $80 by March expiration, the short-terms calls would expire worthless, but the longer-term July calls would be so far out of the money, they would have almost no value left. Here the investor could sell out of the positions for pennies or hope for a miracle. However, if the stock fails to reach $100, the longer-term calls would also go to zero, and the investor would lose his $1.50 investment.
If the stock traded up to $130 by March expiration, both sets of calls would be so far in the money, they would essentially have the same value, made up of entirely intrinsic value. So the $1.50 paid for the position would be gone.
It is recommended to execute a long calendar spread with calls if you expect a stock to trade higher, but that move will be in the future after the short-term calls have expired.