Calendar Spread

 

“Limited risk/reward trade also known as a time spread or horizontal spread”

 

Overview/General Remarks

The calendar spread is a potentially powerful ally in any options trading tool belt. The calendar spread can be used with either puts or calls or both, in the case of a double calendars(discussed later). If a trader believes price will finish at price X then buying the calendar spread at that strike would be ideal.

Calendar spreads can also serve as an income strategy. For example, sell the nearer month option OTM and allow it to expire worthless, simultaneously purchase an option a few months out. Repeat the process until time runs out on the long option or until the trader is satisfied with the profits from the entire position.

One important note with regards to calendar spreads is they generally move slowly. Meaning, they neither profit, nor lose money very quickly. Likely making it a perfect companion for the inexperienced trader.

The calendar spread is an awesome options trading strategy that can be deployed in a number of different ways or scenarios. It is easily adjustable and can be skewed up, down, or neutral, depending on market assumption.

 

Expectations

Employ this strategy at any expected price range. If the assumption is price will remain flat, deploy and ATM calendar. If bullish, deploy an OTM call calendar. If bearish, deploy an OTM put calendar.

 

Setup/Construction

The idea is to sell time. Profiting from the rate of decay on the front month option while the longer term option retains most of it’s original value.

Sell any strike put or call and simultaneously buy the same strike further out in time.

Warning – The calendar spread has a front month short option. Be aware of the obligations. For a quick review of option basics click here.

 

Example Calendar Spread

Example trade on SPY etf. Click to Enlarge.

 

 

Max Reward/Loss

Max reward = Cannot truly be calculated as both options are in different expiration cycles. A favorable outcome would be to double entry price. Once the front month contract expires max profit is identical to a long call.

Information from tasty trade.com.

Max Loss = Debit paid to initiate the position.

The blue line peak represents the profit potential for this particular spread. The horizontal section depicts the max loss at expiration.

 

Price Assumptions

Would depend to large degree on how the spread is to be utilized. Generally speaking, price would remain within the desired range.

 

Key Benefits of the Calendar Spread

– Hedged position

– Limited risk

– Low margin requirement

– Positive theta

– Easy to adjust

 

“The Greeks”

Again, this is a multiple contract position. Be sure to view the net greek values to determine portfolio effect. For a review of the greeks click here.

 

Volatility

IV = 10.85%

IV Rank = Less than 1%

This strategy benefits from higher front month volatility and lower back month volatility. The idea being, a greater premium is received with a higher front month vol. and a lower premium is paid with a lower back month vol.

 

Probability ITM/OTM

It would be preferred for the front month short option to expire OTM. Effectively reducing the cost basis on the long call or opening the door to enter another short contract and reduce it further. With no short contract in play it would be preferred to have the long contract finish ITM.

 

Final Thoughts

I couldn’t possibly begin to describe my love affair with calendar spreads in this short article. They are so versatile and can benefit traders in so many ways. The calendar spread is my favorite of all options strategies.

See something I missed? Of course, let me know below.

 

Disclaimer

U.S. Government Required Disclaimer: Options trading products, services, and information are for educational purposes only. All information shared is confidential and proprietary. Your success with this content is entirely dependent upon your actions. You are required to do you own research and due diligence. Options trading products and training programs are for educational purposes only, and are provided with the understanding that I’m not a registered investment adviser and nothing herein shall be construed as a solicitation and/or recommendation to buy, sell, or hold any financial instruments.

Recognize that the purchase of, sale of, or giving of advice regarding foreign currencies, commodities, stocks, options or futures can only be performed by a licensed, registered or exempt person. Understand that I do not solicit or execute trades or give investment advice, I am not registered as a broker or adviser with any federal or state agency, and encourage consultation with a licensed representative or registered investment professional prior to making any particular investment or using any investment strategy. Stock and options trading has large potential rewards but also involves large potential risks, and that as an investor, you should only use and/or risk capital you are prepared to lose.

This program is intended solely for the avocation, personal enrichment, and enjoyment of students. Your success depends on your unique skills, time commitment, and individual effort. Recognize that neither unique experiences, past performances, historical tests, nor included or accessible strategies, scans, or patterns constitute recommendations or guarantee future results. You are solely responsible for the selection of your own stocks, currencies, options, commodities, futures contracts, strategies, and scans, and monitoring your brokerage account(s), the programs and anything, including, without limitation, delays or outages of any type, which may adversely affect you.