Options Strategy Calendar Spread

What is a Calendar Spread?

A Calendar Spread is an options or futures strategy constructed by entering a long and short position at the same time under the same asset but have contrasting expiration dates.

In a usual calendar spread, a individual would buy a longer-term contract and short a nearer-term option with a corresponding strike price. If two dissimilar strike prices are chosen for each month, this is known as a diagonal spread.

Calendar spreads are also known as inter-delivery, intra-market, time spread, or horizontal spreads.

Understanding Calendar Spreads

A standard calendar spread trade requires the sale of a call or put option that has a near-term expiration date and the concurrent purchase of a call or put option that has a longer-term expiration. Both options are of the same kind and generally use the same strike price.

  • Sell near-term call/put
  • Buy longer-term call/put
  • Recommended but not essential that implied volatility is low.

Where as a reverse calendar spread takes the opposite position and requires buying a short-term option and selling a longer-term option on the same asset.

The purpose of this strategy is to profit from the passage of time and/or a rise in implied volatility in directional netrual strategy.

Given that the goal is to profit from time and volatility, the strike price must be as close as possible to the underlying’s price. The trade benefits from how near- and long-dated options function when time and volatility change. A rise in implied volatility, all other things remain the same, will have a positive affect on this strategy since longer-term options are more reactive to changes in volatility (higher vega). But the two options might and presumably will trade at different implied volatilities.

The passage of time, everything else being the same, would have a positive affect on this strategy at the start of the trade up to the expiration of the short-term option. Following this, the strategy is only long call whose value decays as time passes. Typically, an options rate of time decay (theta) increases as its expiration approaches.

Maximum Calendar Spread Loss

Seeing as this is a Debit Spread, the total loss is the value paid for the strategy. The sold option is closer to expiration and as a result has a lower price as opposed to the bought option, yielding a bet debit or cost.

The perfect market move for profit is a stable to moderately declining asset price through the duration of the near-term option accompanied by a powerful move higher through the duration of the long-term option, or a profound shift upward in implied volatility.

At the expiration of the near-term option, the greatest yield would take place when the asset is at or marginally under the strike price of the expiring option. If the asset were higher, the expiring option will have intrinsic value. When the near-term option expires worthless, a trader only has a long call position, that has unlimited profit potential.

To sum up, a trader that has a bullish longer-term outlook might lessen the cost of purchasing a longer-term call option.

Calendar Spread Example

Suppose that fictional company XYZ stock is changing hands at $89.05 in mid-january, you can enter into the calendar spread below.

  • Sell the February 89 call for $0.97 ($97 for one contract)
  • Buy the March 89 call for $2.22 ($222 for one contract)

The gross cost (debit) of the spread is (2.22 – 0.97) $1.25 (or $125 for one spread).

This calendar spread would be most profitable if XYZ shares stay flat until the February options expire, permitting the trader to collect the premium for the option that was sold. Then, if the stock moves higher in the middle of then and March expiry, the second leg would profit. The best market move for profit is for the price to move violently in the near term, but to gradually rise, closing just under 95 as of the February expiration. This lets the February option contract to expire worthless and still enables the trader to profit from price increases until the March expiration.

Seeing as this is a debit spread, the ceiling loss is the total paid for the strategy. The option sold is nearer to expiration and consequently has a lower price than the option brought, yielding a cost or net debit. In this situation, the trader is anticipating to capture an increase of value linked with price appreciation (up to $95 but no more) between purchase and February expiration.

Keep in mind that if the trader were to buy the March expiration, the cost would have been $222, but by using this spread, the cost needed to make and hold this trade was just $125, making the trade one of increased margin and reduced risk. Determined by which contract type and strike price are selected, the calendar spread strategy can be employed to profit from a flat, bullish, or bearish market trend.

Option Strategy Calendar Spread Conclusion

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