Calendar spreads combine buying and selling two contracts with different expiration dates. With calendar spreads, time decay is your friend. You can go either long or short with this strategy. It’s an excellent way to combine the benefits of directional trades and spreads.
Options have many strategies that allow you to profit in any market, and calendar spreads are just such a strategy. Who doesn’t like being able to make money in a sideways market and an up-and-down market?
Options are great for growing a small account without trading penny stocks. You’re vulnerable to sector manipulation. Options are different, however. You can’t pump and dump options or the large-cap stocks that trade options.
What Are Calendar Spreads?
Calendar spreads are useful in any market climate. Ultimately, utilizing this strategy is an effective way to minimize risk. If you want to use calendar spreads for income, the good news is that calendar spread earnings tend to be higher than other debit or credit spreads.
With this trading strategy, time decay is your friend. Also, with knowledge of the proper management techniques, you can do well for yourself trading calendar spreads.
To utilize a calendar spread strategy, you buy and sell two options. You may trade two calls or two puts, but each is the same type. Additionally, you use the same strike price for both.
The only difference is the expiration dates. For example, you may create one option that expires in a month, then set the second one to expire in two months. Since the dates differ, calendar spreads are called “time spreads” or “horizontal spreads.”
You can go long or short on your spread. To initiate a long calendar spread, you sell the option with the earlier expiration date and buy the option with the later expiration date.
For a short calendar spread, you do the opposite. You buy the option that expires earlier and sell the option that expires later. Buying short-term and selling long-term is also called a “reverse calendar spread.”
Volatility & Time Advantages
For your calendar spread, you want your strike price to be at or near the underlying asset’s price. Your objective is to profit from volatility and time.
The longer-term option is affected more significantly by higher Vega (changes in volatility). Therefore, the increase in implied volatility impacts this strategy positively.
Just to let you know, both options you trade will usually be subject to different implied volatility. C
Time should have a positive effect on the near-term option until it expires. Then, the value of your later-term option should erode over time.
The theta (decay rate) increases closer to the expiration date. As a result, the calendar spread requires management.
You’ll spend time monitoring and possibly adjusting them. Before setting up your spread, please take a look at your risk profile.
A tool like the ThinkorSwim platform makes this easy. Just use the Analyze tab to create a graph.
Check the breakeven range for the underlying asset’s price on the day when the near-term asset expires. You may need to adjust if the price is too close to the top or bottom of the breakeven range.
Calendar Spreads Example
Call Calendar vs. Put Calendar Spreads
What is a call calendar spread? Summed up, a call calendar spread utilizes two calls. Meanwhile, a put calendar spread utilizes two puts. You may go long or short on a call or a put with options. With a calendar spread, both options are the same type. However, you can create long-call or short-call calendar spreads. Likewise, you can create long-put or short-put calendar spreads.
In the case of all of these strategies, you create both options with the same strike price. Note that you only use different strike prices for a variation on this strategy, like when you create a diagonal calendar spread.
Now, let’s look at these strategies in a little more detail.
Long Call Calendar Spread
With this spread, your near-term outlook is neutral to bearish. However, your longer-term outlook is bullish.
You go short on your call option that expires earlier and long on your call option that expires later. Your objective is to profit from the underlying asset’s price remaining steady or falling by the time your near-term option expires.
If it expires worthless, then you own the option that expires later, free and clear. Your maximum gain on this strategy is potentially unlimited, while your maximum loss is the net premium.
Short Call Calendar Spread
You buy your call option that expires earlier and sell your call option that expires later. The objective is to profit from a sharp move in the underlying asset’s price for your near-term option.
In this case, your maximum gain on this strategy is the net premium. However, this strategy is riskier because your maximum loss is potentially unlimited.
Long Put Calendar Spread
With this long put spread, your near-term outlook is neutral to bullish. However, your longer-term outlook is bearish.
You sell your put option that expires earlier and buy your put option that expires later. Your objective is to profit from the underlying asset’s price remaining steady or rising slightly for your near-term option.
If it expires worthlessly, then you own the option that expires later, free and clear. Your maximum gain on this strategy is the strike price minus the net premium, while your maximum loss is the net premium.
Short Put Calendar Spread
To initiate this short put strategy, you buy your put option that expires earlier and sell your put option that expires later.
Your objective is to profit from a sharp move in the underlying asset’s price for your near-term option.
In this case, your maximum gain on this strategy is the net premium. However, your maximum loss is the strike price minus the net premium, and this loss could be substantial.
Futures Spread
What is a future spread? Is it different from using a spread with a stock as the underlying asset? The most common type of spread utilized for futures is a calendar strategy.
For example, if you believe the price will rise, you create a near-term buy position and sell the longer-term position. Unless you own the underlying commodity, a single-leg option is riskier.
Creating a spread enables you to profit from both positions or at least have one leg offset losses from the other leg. Another benefit of utilizing futures calendar spreads is the lower margin.
Since the two positions essentially hedge each other, this lowers the price volatility. What makes futures different is that supply and demand have the greatest effect on calendar spreads.
Consider the case of a sufficient supply of wheat, for instance. The “cost of carry” price generally causes the longer-term position to trade much higher than the near-term position.
Meanwhile, the opposite occurs if the commodity is in short supply. In that case, the near-term positions would trade higher than the later-term positions. The market itself rationed demand.
If you trade calendar spread futures, historical data plays an important role in your analysis. See how the commodity has performed during that season under similar circumstances.
Final Thoughts: Calendar Spreads
Calendar spreads are a valuable strategy to add to your options trading arsenal of knowledge. It’s one of a number of strategies that you can deploy besides others like straddles, strangles, or wingspreads.
Additionally, it’s important to understand the various options and strategies, and when it’s best to use which one.
If you’d like to learn more, like the role of the Greeks, the risks associated with your choice of expiration date, and when to buy or sell, we can show you.
