Does anyone understand why thetas for ITM call options provide motivation for short calendar spreads? See p.267 (reading 15). They say that an ITM OCT 40 call will lose time value more rapidly than an ITM SEP 40 call (the stock is trading at $45).
I would appreciate it if you could share the rationale!!
First, I just show my opinion.No guarantee of the correctness
For Theta, it means the sensitivity to a decrease in time to expiration,it is always negative, but for the put option that is deep in the money, it may be positive because the long side eager to exercise the option as soon as possible to earn more money (since maybe the underlyng price can’t drop further)
So, if the time decay is good for the long side, Theta will become larger than before, for example, it may change from -2 to -1 or even positive, if the time decay is bad of the long side (for example,for the option which is deep out of money) the Theta will become smaller, for example, -2 to -3
Therefore, if the call option is just in the money, so the long side may be more eager to exercise the option now, so, it is easy to suppose currently,the Theta of the call option matures in SEP is -1, the Theta of the OCT option is -2 (because the earlier the option matures, the better)
So, it is easy to see that an ITM OCT 40 call will lose time value more rapidly than an ITM SEP 40 call, because the Theta for the OCT is smaller than the Theta in SEP
Short calendar spread means that we buy the SEP option while sell the OCT option, so, the net theta we can calculate approximaterly like this, use our suppose mentioned: -1+2=1, so we gain the time value.