A calendar spread is a strategy used in options and futures trading: two positions are opened at the same time – one long, and the other short. Calendar spreads are also known as ‘time spreads’, ‘counter spreads’ and ‘horizontal spreads’. In the options strategy version, calendar spreads are set up within the same underlying asset and strike price, but different expiration dates. In futures, this strategy is only utilizing two (or more) different expiration dates and (typically) doesn't include the buying and selling of call and put options. This piece focuses on options calendar spreads.
This strategy is ordinarily used when the directional assumption of the underlying is neutral, i.e. used in the lowest of implied volatility (IV) environments. But, it can also be successful when you’re a little bit bullish or bearish. When your speculation is that the market will be neutral, but you think the underlying price might move up slightly, you’d go for an out-of-the-money (OTM) call calendar. Whereas if you’re neutral, but you’re mildly bearish, you’d go for an OTM put calendar.
Either way, to try and collect more premium (and reduce the cost basis) of the long option you’re buying, you’d sell the nearest OTM call or put (short position). You’d then use the same strike price on the long position that’s further out in time. If you use different strike prices, it wouldn’t be a calendar spread – it would be a diagonal spread.
But, if you think there’ll be minimal movement in the underlying’s price (i.e. not really bullish or bearish), you could go for at-the-money (ATM) options. The idea is that the long option retains or gains extrinsic value, and the short option loses extrinsic value as time passes. This is a pure extrinsic value trade, as both the long and short option are on the same strike, cancelling out any intrinsic value if the spread moves in-the-money (ITM).
A calendar spread is a low-risk, directionally neutral strategy that profits from the passage of time and/or an increase in implied volatility.
The calendar spread strategy works by entering a short option (call or put) in a near-term expiration cycle, and a long option (call or put) in a longer-term expiration cycle on the same underlying asset. Both options are of the same type (either call or put) and use the same strike price.
While it’s possible to have the long option in a near-term cycle, and the short option with a longer-term expiration date, this generally requires a lot of capital since the extrinsic value risk is now in the short option. So, this route kind of flies in the face of an essential part of the calendar spread – being a strategy with one of the lowest capital requirements.
Buying the longer-term option and selling the shorter-term option increases capital efficiency, which means it doesn’t require a lot of buying power – making it suitable for individual retirement accounts (IRAs). This capital relief wouldn’t apply if your short option’s duration exceeded the expiration cycle of the long option. Further, more rapid time decay in the short, near-term option (higher theta) than in the longer-term option that’s bought is typically how a profit is made in a calendar spread.
The exact maximum profit potential and breakeven cannot be calculated due to the differing expiration cycles used. However, the profit potential and breakeven area can be estimated with the following guidelines.
One of the most positive outcomes for a calendar spread is for the trade to double in price
A guideline we use is within 1 strike of the calendar spread’s strike price
There are two things to remember when it comes to calendar spreads:Keeping this information in mind is most helpful when setting up the trade. We pick strikes that are near the stock price, if not right on the stock price. We may skew it slightly bullish or slightly bearish if we have a small directional assumption, but it will be very close to the stock price regardless – that gives us the most exposure to profit or loss with changes in implied volatility. You will only see us routing this strategy in the lowest of IV environments.
Since a calendar spread can be hurt by too much stock movement, we tend to manage our winners at around 25% of the debit we paid to enter the trade. Waiting too long for additional profits could mean stock price movement, which can be bad for the position. We never route calendar spreads in volatility instruments. Each expiration acts as its own underlying, so our max loss is not defined.
Since this is a debit spread with defined risk, we don’t usually manage it. We are comfortable with the debit paid as max loss, and there’s not much we can do with these spreads regardless since they share the same strike.
Let’s move into practical territory and unpack calendar spread examples. Before we jump in, remember that the ideal route for capital efficiency is selling a short-term option and buying the longer-term option on the same strike. This way you’d benefit from the low capital requirement of the calendar spread strategy.
Suppose you’re neutral but mildly bullish on Company XYZ. You enter a long calendar spread with calls when shares of the stock are trading at $50.00 – you buy a 55 call with 90 days to expiration (DTE) and sell a 55 call that expires in 45 days.
You pay a premium of $5.00 for the long position and receive a premium of $3.00 for the short call, giving you a net premium (debit) of $2.00. This would be $200.00 in total as one options contract represents 100 shares – $200.00 would also be the maximum possible loss for your calendar spread.
Fast-forward 45 days, the short option expires worthless when the underlying’s price increases to $53.00. Since the short call position is bearish, and the new market price is below the strike price, this option expires OTM.
In this case, if the long option is worth more than $2.00, you’d see a profit on your overall position, since you paid $2.00 upfront for the calendar spread. If the remaining long $55.00 call, that still has 45 DTE is worth $3.00, you’d have a net profit of $1.00, or $100.00 in real-dollar terms. You paid $200.00 for the calendar spread, the short call expired worthless, and now your long call that remains is worth $300.00.
In a long put calendar spread, you’d also have two positions with the same strike price: sell the front-month option with 30 to 45 DTE, and buy the back-month option, with 60 to 90 days to expiration. The net premium would be a debit, just like in long call calendar spreads.
Suppose you’re neutral, but mildly bearish on Company XYZ. You enter a long calendar spread with puts when its shares are trading at $100.00 – you buy a 95-strike put with 90 DTE and sell a 95-strike put that expires in 45 days.
You pay a premium of $9.00 for the long put position and receive a premium of $4.00 for the short put, giving you a net premium (debit) of $5.00. This would be $500.00 in total as one options contract represents 100 shares – $500.00 would also be the maximum possible loss for your calendar spread.
The short option expires worthless (in 45 days) when the underlying’s price drops to $96.00. Since the short put position is bullish, and the new market price is above the strike price, this option expires OTM and worthless.
In this case, if the long option is still worth $7.00, you’d see a profit on your overall position, since you paid $5.00 upfront for the calendar spread. If the remaining long 95 strike call (that still has 45 DTE) is worth $7.00, you’d have a net profit of $2.00, or $200.00 in real-dollar terms. You paid $500.00 for the calendar spread, the short call expired worthless, and now your long call that remains is worth $700.00.
In a short calendar spread, there are two positions with the same strike price: sell the back-month option, e.g. with 60 to 90 DTE, and buy the front-month option, e.g. 30 to 45 days to expiration. So, the net premium would be a credit.
Potential profits are limited to the credit received upfront with a short calendar spread. Losses are somewhat unknown as we can’t predict a large spike in IV% in the short option, which would send the extrinsic value through the roof. The short calendar spread could be viewed as short-term delta protection against the short option, where the long calendar spread could be viewed as a cost-basis reduction against the long option you own. Both calendar spread variations are pure extrinsic value trades.
So, how do short calendar spreads differ from long calendar spreads?
Short calendar spreads with calls and puts profit from bigger movements of the underlying’s price (away from the strike price); long calendar spreads profit from smaller movements near the strike price.
Another key difference between a short calendar spread and a long calendar spread is that the options are swapped around on the basis of DTE.
The near-term is the long call option (insurance against intrinsic value losses on the short call if it moves ITM); whereas the longer-term position is the short call (which has the most extrinsic value, and holds all the potential profit)
The near-term is the long put option (insurance against intrinsic value losses on the short put if it moves ITM); whereas the longer-term position is the short put (which has the most extrinsic value, and holds all the potential profit)
Calendar spreads’ probability of success is around the mid-forties – which isn’t that bad considering that you can’t lose very much using this strategy. The reason why it’s not a very high probability strategy is because these are pure extrinsic value trades. You cannot have the stock price go too far away from the strike price. If that happens, extrinsic value starts to go away, and the trade becomes a loser.
The typical calendar spread, selling the near-term call or put, and buying the longer-term call or put, profits when there’s:
Keeping this information in mind is most helpful when setting up the trade. So, strikes should be near the stock price, if not right on the stock price. While it may be skewed slightly bullish or slightly bearish if you have a small directional assumption, it should still be very close to the stock price regardless.
With the probability of success being around the mid-forties, seasoned traders usually have a smaller profit target – the ideal range is 10% to 25% of the premium paid. The success rate for making above 25% of the premium paid is lower but making below 10% usually doesn’t pay enough.
The break-even for a calendar spread cannot be calculated due to the different expiration cycles being used. The long option will still remain when the short option expires, and we don’t know how much extrinsic value that option will have.
Calendar spreads could be the way to go if you’re looking for a low capital requirement strategy (not too much buying power). But don’t forget the essentials – having a neutral directional assumption on an asset with low volatility and a stock price that you think won’t move around too much.
A long put calendar spread is a neutral-bearish options strategy where an OTM put option is purchased in a long-term expiration, and the same strike OTM put option is sold in a near-term expiration cycle.
Two put positions (short and long), with the same strike price and different expiration dates, are required to form a put calendar spread. Since the options are on the same strike, this is a pure extrinsic value trade where you want the long option to retain or gain extrinsic value, and you want the short option to expire worthless.
The typical calendar spread is a debit spread, with defined risk. If you’re comfortable with the net premium (debit paid) as maximum loss, you don’t have to manage the spread.
Since too much stock movement is bad news for a calendar spread, managing winners around 10% to 25% of the total debit paid for a calendar is often the best way to secure profit without holding the trade too long. Profit targets outside this range means not receiving enough (under 10%) or facing a low success rate (above 25% doesn’t happen regularly enough).
Selling a calendar spread simply refers to short calendar spreads with calls or puts, where the short option has a long-term expiration and the long option has a near-term expiration that’s purchased to define intrinsic value risk on the short option.
A double calendar spread is simultaneously purchasing two sets of a standard calendar spread that are based on the same underlying – that means four options contracts in total – for increased exposure. While a single calendar spread has only one option type, either call or put, a double calendar spread has both.
Here’s an example of a double calendar spread:
Call calendar spreads can be set up to be slightly bullish. Moving the strikes slightly OTM will reduce the cost of the overall spread, but increase the potential for the long option to gain a higher value on a % basis if the stock moves towards the strikes.
Waiting too long for additional profits could mean more stock price movement, which typically is bad for long calendar spreads. The true risk is the debit paid upfront, if the spread expires worthless.
In the case of short calendar spreads, which aren’t as popular as long calendar spreads, risk exposure is magnified as the remaining short contract essentially becomes a naked option once the near-term option expires.
A short calendar spread is purchasing two options of the same kind, one long and one short, at the same time and choosing a later-dated expiration month for the short position. Both the underlying and the strike prices, however, would be the same. The long option acts as short-term insurance on the short option’s intrinsic value risk if it goes ITM.
A long calendar spread is a strategy where two options that were entered into simultaneously, have different expiration dates: the short option expires sooner than the long option of the same type. But, the underlying asset and strike prices will be identical in each position. The long option is the asset in this setup, and we want it to either maintain its value, or increase in value, as the short option decays over time.
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