What are Calendar Spreads? | Calendar Spread Options Strategy
Calendar spreads are a low-risk options strategy that you can use to take advantage of the volatility term structure with a slight directional bias.
Key Takeaways
A calendar spread is an options trading strategy that involves buying and selling options with different expiration dates but the same strike price.
The strategy is used to take advantage of differences in implied volatility and time decay between the two options.
Calendar spreads can be constructed using either call options or put options, depending on the investor's outlook for the underlying asset.
The potential profit for a calendar spread is limited to the difference between the premiums received from selling the option with the nearer expiration date and the premiums paid for the option with the later expiration date.
The potential loss for a calendar spread is limited to the net premium paid for the options.
Calendar spreads are considered to be a relatively low-risk options trading strategy that may be suitable for investors with a moderate risk tolerance.
What is a Calendar Spread?
Calendar spreads, also known as time spreads, are an options trading strategy that involves buying an option and selling an option with the same strike price but different expiration dates.
You can trade a call or put calendar spread, but the strategy is relatively neutral either way. However, put calendars will give you a slight bearish bias, while a call calendar spread is slightly bullish.
The calendar spread is excellent when front-month volatility is much higher than back-month volatility. Earnings plays are a good example of when front-month volatility may be higher than back-month volatility.
The calendar spread is also one of the few options strategies where you have positive theta and positive vega. This means you benefit from time decay and an increase in volatility.
Calendar spreads are relatively low risk and are not volatile positions, meaning you will not see them move a whole lot. The calendar spread also doesn’t use much buying power, as the only requirement is the initial debit you pay to open it.
How to Set Up a Calendar Spread?
To set up a calendar spread using put options, you generally will go to the expiration 45+ DTE and buy a slightly OTM put. Next, you go to a shorter expiration date and sell the same strike put.
Ideally, the implied volatility of the short-term expiration will be higher than the longer-term option giving you a better chance to profit. When the VIX term structure is in backwardation, calendar spreads are a solid way to take advantage of the volatility curve.
Calendar Spread Max Loss
The max loss of a calendar spread is the debit you pay to open it. Since you are trading the same strike prices, the long option will essentially always be worth more than the short-term option.
Calendar Spread Payoff Diagram
The payoff diagram of a calendar spread demonstrates why the strategy is neutral, as the profit zone is right around the strike price.
You can’t accurately calculate the breakeven of a calendar spread since there are multiple expiration dates. The max profit of a calendar spread is realized if the short option expires while the underlying is pinned on the strike price.
Example of a Calendar Spread
Let’s say stock XYZ is trading at $100 per share, and you are slightly bearish to neutral. You can buy the $95 strike, put expiring in 60 days, and sell the $95 strike, put expiring in 45 days.
Ideally, the 45 day expiration cycle has a higher implied volatility than the 60 day option providing you with an extra edge.
If the underlying moves down slightly, your long put will profit, while the short option will decay quicker due to the more aggressive theta decay.
Calendar Spreads | Bottom Line
In conclusion, calendar spreads, also known as time spreads, are a low-risk options trading strategy that involves buying an option with a later expiration date and selling an option with a shorter expiration date.
The strategy is relatively neutral and benefits from time decay and an increase in volatility. To set up a calendar spread, you can buy a slightly out-of-the-money put option with a longer expiration date and sell the same strike put option with a shorter expiration date.
The max loss of a calendar spread is the debit paid to open it, while the max profit is realized if the short option expires while the underlying stock is pinned on the strike price.
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