Short-Term Calendars on the SPY

Time spreads, and in particular calendar spreads, are one of my absolute favorite option strategies. Long calendars give an option trader a lot of options. They can be used as a neutral or directional strategy, and they mainly profit from time passing – hence the name time spreads. Having three expirations a week on the SPDR S&P 500 ETF (SPY) gives an option trader even more choices to consider as far as expirations go. Let’s look at a calendar we recently explored in group coaching class.

SPY Calendar

The SPY was trading near some potential resistance in the $440 area on a recent Wednesday. Excluding the current day’s expiration, the next two would be Friday and then Monday. Many option traders including myself like to set up long calendars by selling that Friday’s expiration and buying the following week’s expiration for an underlying that has serial weeklies. But having an expiration essentially one trading session apart (Friday and Monday), an option trader can reduce the cost and risk of the trade and increase the reward to risk ratio potentially too. We looked at selling the Mar-04 (Friday) 440 call and buying the Mar-07 (Monday) 440 call, as seen below.

The cost of the calendar was 1.17 (3.76 – 2.59). The two things that are definite about a long calendar are the risk of the trade (the cost) and where the max profit is earned, which is if the underlying is trading exactly at the short strike at the short strike’s expiration ($440 at the close of Mar-04). The IV is higher (27.79%) for the short call versus (23.06%) for the long call, which reduces the cost of the trade compared with a calendar with no IV skew. The main source of income is positive theta. In this case, the current positive theta is 0.50 (0.97 – 0.47). The short option is losing more premium than the long option.

P/L Diagram

The P/L diagram is a guesstimate. The max profit and the break-evens are approximations based on the current premiums, IV levels and option greeks because of two different expirations. Below is the P/L diagram for the trade idea above based on the cost of 1.17.

Although you may not be able to read it from the chart above, the maximum profit was estimated to be around $230 and the two break-evens were estimated to be around $432.80 and $447.10. Again, it is an estimation, but the difference in the break-evens was over $14 wide. That certainly gives the SPY a fair amount of wiggle room to profit. The position does not have to be held to the short call’s expiration to potentially profit because the position has positive theta as defined above.

Finally

Because the long and short expiration are so close, the risk/reward is usually much better than a long calendar that is a week apart in expiration. As an option trader, being able to improve the risk/reward is not always easy without decreasing the odds of success. However, this may be one of those times.

John Kmiecik
Senior Options Instructor
Market Taker Mentoring, Inc.

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