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Effects of Stock Price on the Time Spread

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The price of a time spread fluctuates with movements in stock price. A time spread is at its widest when the stock price and the strike price of the spread are identical or at-the-money.

As the stock moves away from the strike in either direction, the value of the time spread decreases. As the stock moves in either direction from the spread’s strike, the closer month will experience a quicker price change due to the front month’s higher gamma.

Gamma shows the rate of change of an option’s 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 holds true. As the stock price moves closer to the strike price, the value of the time spread increases.

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 or highest value. As the stock climbs from $65 and pushes toward $70, the June / July 65 spread loses value.

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 trade 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. Meanwhile, 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.

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