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Calendar Spread – Selling ‘Time’

Calendar Spread

The calendar spread is one of the most basic and easy to understand option strategy.

With the calendar spread we are ‘selling time’ – or to be more specific, we are selling an option that has time premium – with the intention to allow that time premium to melt away as time passes – leaving us with a profit.

To protect ourselves from a huge move in the underlying we are trading – we also purchase an option – usually at the same strike as the option we are selling – and the option we are purchasing is an outer month – or an option with more time left in it before expiration.

Calendar Spread – Example

For example – let’s say we are going to place a calendar spread on our favorite stock XYZ. XYZ has been trading in a range for awhile and we expect it to continue doing so – making it a good candidate for a calendar spread (remember, we want to choose an underlying that we expect to to stay somewhat within it’s range).

So, with XYZ trading at $40.00 – we sell one August 40 strike call (in this example August is the month we are in and there is about 3 weeks left to expiration). At the same time we sell the August option, we purchase an October 40 call option as protection.

As long as our stock XYZ stays close to where it is trading at now – over time, the 40 strike option will lose value day by day at a rate faster than the October 40 call. This difference in decay rate is what will give us our profit.

Calendar Spread – Rinse and Repeat

And – if things go as planned and XYZ does stay close to the 40 dollar strike price – and we DO wind up taking a profit on the position – once August expiration comes around we can the evaluate the market / XYZ stock and decide if we wish to do the same thing again – only this time, since we already own the October 4o call option, all we will need to do is sell the September 40 call with the goal of milking another months time decay.

To learn more about this strategy – as well as other ways to play the calendar spread such as diagonal calendars, reverse calendars, double and triple calendars spreads and more, be sure to join our FREE option income trading email newsletter by CLICKING HERE



Calendar Spread

The calendar spread is an option income strategy used by professional traders to generate steady monthly income. It can also be used by retail traders who have educated themselves on how to properly use this strategy to not only generate cashflow – but to also benefit their overall portfolio.

The calendar spread is a theta trade – an option trade that benefits and generates profit – from the fact that options are a decaying asset. As time goes by, options decay – and the value that was initially in the option that was sold evaporates – leaving cash in the calendar spread traders pocket.

Calendar spreads can be constructed from both call options and put options. To build a calendar spread position, one sells a closer month option at a particular strike – and then purchases a further out month option at the exact same strike. This spread makes money due to the fact that the value in the closest month option deteriorates at a quicker rate then the farther out month option. This difference in the value decay of the two different month options is what helps to create the profits in these trades.

Following is an made up example of a calendar spread place on SPY: Buy 1 Aug 105 call. Sell 1 Sept 105 call.

Now while in the example above the calendar position was created using joined together months, calendar spreads can also be created with a gap between the months.

For example, rather than constructing a calendar spread using Aug and Sept month options, it could be created using a Aug month option and an Oct month option – or a Aug month option an a Nov month option.

Typically calendar spread traders will utilize this strategy when they believe the underlying vehicle they are trading will stay in a range – or will wind up on expiration day close to or right at strike price which was sold.

When you talk with some option traders, some will tell you they prefer the calendar spread strategy because they believe they are easier to manage than some of the other strategies like the iron condor, credit spread, or the butterfly spread. Regardless, the calendar spread is a great strategy to learn and have ready to use in your ‘option trading toolbox’.

Calendar Spread – Adaptations and Techniques

Calendar Spread – Defined

In Future & Option market, a calendar spread also known as horizontal spread or time spread is a kind of spread trade which takes place by simultaneous buying of options or futures having the expiry at a specified date and sale of the similar instrument which has another expiring date. The legs of spread differs in expiration date only however the strike price and underlying market remaining same. Usually the case involves the buying of options or futures for a distant month and the sale of options or futures for a nearby month. The calendar spread may be utilized for trying to gain advantage of the difference which occurs owing to implied volatilities in between two different options of each month. An investor will generally adopt this technique when the options one is purchasing have a noticeably lower kind of implied volatility in comparison to the options one is selling or writing.

Calendar Spread – Characteristics

In the characteristic adaptation of this technique, a surge in the entire implied volatility in respect of options of a market at the time of the trade will have a tendency to move strongly in favour of the trader and lowering in implied volatility will be disadvantageous for the trader. In case the investor instead purchases a near month’s options in few underlying stock and sells the same underlying stock’s further out-of-the money options of the identical strike price, this is called as the reverse calendar spread. This technique will be advantageous when a fall in the entire implied volatility in respect of market’s options with passage of time.

Calendar Spread – Techniques

There is another technique which is called neutral calendar spread technique which is adopted by purchasing long term calls and at the same time selling or writing an identical number of nearby month little bit out-of-the –money or at-the-money calls in respect of the identical underlying asset having the identical strike price. When an option trader applies the technique of selling one nearby month at-the-money call and buying one long term at-the-money call becomes neutral in respect of the underlying stock for a short period of time and sells the nearby month calls to earn profit from the quick time decay. However, the profit which can be earned by the application of neutral calendar spread remains confined to the premiums obtained by selling or writing the nearby month options and the amount for time decay for the longer time options is being deducted from the premium amount received. The maximum amount of loss for adopting the neutral calendar spread remains confined to the initial premium paid for taking the position on the spread. It happens while the stock price falls and remains at the lower band till the expiry of the option in respect of longer term. An illustration for neutral calendar spread is followed here.

In the month of May, and options trader thinks that ABC stock trading at $50 will be trading in range bound manner in the next trading sessions of coming few months. He opts for the neutral calendar spread by purchasing a Sept 50 call for $450 and sells or writing a June 50 call for $250. The net amount needed to go for the spread is the premium difference of $200 debit. As speculated by the trader, ABC stock price reached the level of $50 on the date of expiration for the short term call and the June 50 call becomes worthless. The Sept 50 call lost some of its value owing to time decay however is worth $350 still and by selling this call, the trader managed to pocket $150 after considering the initial debit of $200 paid by him. In case the price of ABC stock had declined instead to $47 and remained at $47 till the expiration date in the month of September, the trader had to bear a loss of $200 which was his total investment for the trade.

Similar to all calendar spread techniques, it is imperative to take decision on which follow-up strategy to adopt while nearby term options expire. This decision relies largely on the back drop of the outlook for the underlying during that time. If the trader thinks that the implied volatility has a chance to enhance significantly, the trader may plan to remain invested up to the long term call to earn profit from type of big surge in price movement which may happen. On the other hand, if the trader thinks that underlying implied volatility will stay at lower level, then he or she may opt for another neutral calendar spread by selling or writing another nearby term call. However, it the trader is not sure about the movement of the underlying, it will be suitable for him or her to book profit or loss according to market scenario and contemplating for other trading opportunities.

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Calendar Spread – The ‘Time Spread’

Calendar Spread – Option Strategy

This article is in regards to the calendar spread trade. When an option remains in a position which the expiration date is several months away, it is seen that time decay is comparatively slow. With the passage of time, the rate of time decay or the option’s theta increases. When the option’s expiration date settles within less than thirty days to expiration, time decay changes rapidly. Typically the Calendar spread is utilized in this situation.

Calendar Spread – Horizontal Trade

In a characteristic horizontal type calendar spread, one sells an option and as well as purchases another option of the identical type whatever it might be i.e. put or call on the same underlying stock and at the identical strike price however with a further expiration. When number of month’s remains for the option prior to its expiration, the time decay is comparatively slow. With the passage of time the rate of time decay increases. The time decay goes into full force, when the option has less than thirty days remaining. Calendar spreads take advantage of this typical situation. In a characteristic horizontal type of calendar spread, one sells and simultaneously buys another option of the identical type which may be put or call one the identical underlying stock and at the identical strike price, having more out expiration. Here is one illustration of calendar spread mentioned below for clear understanding.

Calendar Spread – Example

Suppose one option trader wants to take position in stock market applying the technique of calendar spread and he or she opts for selling or writing one for the month of June 50 call for which the underlying price is 50.00 and for selling the call one receives 1.96 as premium while the expiration days is due after thirty days and implied volatility is 32.6% and at the same time he or she purchases one 50 July call for the same underlying and pays an amount of 2.53 and the relevant time due for expiration against this call is 58 days and the corresponding implied volatility is 29.4% Therefore, the net cost of the spread become -0.57. Now what happens is that in case of June 50 call the loss of premium takes place quickly in comparison to the July 50 call, resulting in the spread to extend since in this case vale of the spread will enhance. For trading purposes the best situation in respect of the underlying will be when the same is trading at 50 and the June 50 call becomes worthless because of expiration. However, the July 50 call having twenty eight days remaining still in place of fifty eight days will be having time premium. Assuming implied volatility maintaining the same 29.4% level, the premium for the July 50 call will be 1.72 in view of the market price. Therefore, the calendar spread that cost one 0.57 will now stand at 1.72 thereby resulting in a profit for 1.15 which is nearly two hundred percent return within one month, although cost of ask/bid slippage and commission are to be deducted.

However, for the above trade to become fruitful, the market has to remain in a range bound and better if it moves in a narrow range. Any big jump in market movement be it in the down side or in the upside will entail loss for the trader. The option one sells must be overvalued in comparison to the option one purchases. It becomes helpful if implied volatility increases. This will enhance the premium for time value of the options one buys that have much time remaining in comparison to the options one sells in calendar spread. One may remember from the section of Option Basics that vega of an option determines the changes in price of the option corresponding to percentage change in volatility. Vega reduces as the date of expiration for the option approaches. In case of calendar spread, the options one purchases have more time left and therefore a bigger vega compared to the options one sells. This denotes that an enhancement in implied volatility will make the price of the option one purchased to enhance more in comparison to the options one sold.

In addition, if one remains in the calendar spread till the options one sold expire, they expires having no time value remaining while the options one purchased will have time value still remaining. When one finds a stock for a calendar spread, one should ensure regarding the possibility of profit factor, which is the price range that the underlying has to maintain for making this method to become profitable. One should also note that what will occur to one’s position if changes in implied volatility takes place and by doing so one will be able to enter into a better trading opportunity. Therefore, in order to make trading by the utilization of calendar spread method one has to be careful about other conditions of the market.

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Welcome To Calendar Spread dot com

This blog will focus on the calendar spread option strategy