If you have attended MTM’s Group Coaching class, you probably know how much I love time spreads. In fact, I even have a T-shirt I like to wear that says so. Calendars happen to be my favorite time spread, usually of the short-term variety. If you are not familiar with them, long calendars consist of selling a call or put and buying another call or put with the same strike but a longer expiration. For me that usually means selling the current week’s expiration and buying the next if there are weekly options available. I like to initiate them early in the week. Positive theta is the main source of potential income for this position, but I like to look at it a little differently.
Like a Vertical Credit Spread
I often compare long calendars to vertical credit spreads like bull puts and bear calls. But instead of buying a lower strike put for a bull put or a higher strike call for a bear call, an option trader buys a longer expiration option to protect the short option. The difference is for the long calendar you do not want the underlying to move too far away from the strike price. The positive theta starts to diminish, and the delta starts to grow. For a bull put spread as an example, it does not matter how high the underlying goes above the short put strike because the spread will still profit.
The biggest benefit for long calendars is that positive theta. The positive theta from the short option has a larger theta than the long option with the negative theta. This positive theta can offset some positive or negative delta risk as the underlying moves higher or lower. If the underlying is around the short strike for a calendar, delta should be close to neutral. But as it goes higher or lower, positive or negative delta will surface. As mentioned above, the more it moves away, the more significant delta becomes and the smaller positive theta becomes. It is like losing your edge on the trade.
Theta is highest at-the-money (ATM) and it is also greatest between expirations when the underlying is ATM too. So, the positive theta edge will diminish when the underlying wanders too far away and it limits its ability to offset delta.
Show Some Love to Calendars
As much as I love calendars, I know they can’t solve the world’s problems. But what they can do for an option trader can be pretty remarkable and darn profitable too!
Senior Options Instructor