Why I Love Calendar Spreads

A calendar spread, which is a member of the time spread family, can be a pretty simple and straightforward option strategy. It’s designed to work somewhat like a covered call but without the initial outlay of cash that can accompany buying shares of stock. The spread profits from time decay and can make money in any direction depending on the strikes that are chosen. How versatile is that?

The Setup

Creating a calendar spread involves buying and selling options on the same underlying with the same strikes but with different expirations. The best case-scenario is for the stock to finish at the strike price at the short expiration, allowing the short-term option to expire worthless. The long option will be at-the-money (ATM) and will retain much of its value.

Calendar Spread Example

Let’s say a stock has been trading pretty much between $75 and $85 for the past several weeks and often hangs out in the middle of the range. An option trader forecasts the stock might stick around that area for a few more days until June monthly expiration about seven days away. The option trader can buy the June-27 (14 days until expiration) 80 call for 2.75 and sell the June-20 80 call for 1.50. This trade is a debit spread and the maximum loss for this trade is $1.25 (2.75 – 1.50).
 
If the stock continues to trade around the $80 level, the calendar spread’s value should increase. The June-27 80 call might now be worth 2.25 and the June-20 182.5 call might have dropped to 0.50 after four days have passed. The spread now would be 1.75 (2.25 – 0.50). A profit could now be made of $0.50 (1.75 – 1.25). That doesn’t sound like much, but a $0.50 ($50 in real terms) profit on a $1.25 ($125 in real terms) investment in just four days is not a bad return in my opinion.

If the stock moves too much higher or lower than $80, the spread’s value will tend to lose premium depending on the move. A huge factor for calendar spreads is that they can still profit if the underlying does not move too far away. Time and implied volatility (IV) factors can affect the position too. One of the main things I personally like about calendars is that if the underlying moves away from the strike price and finds its way back close to the short expiration, the spread can usually still profit a fair amount.

Final Thoughts

There are option strategies for every outlook. Traders just need to know what to look for and how to implement them. In my opinion, time spreads and particularly calendar spreads, are one of the very best because they can profit from a neutral or for that matter a directional outlook. It really blows my mind how many option traders fail to consider this!

John Kmiecik
Senior Options Instructor
Market Taker Mentoring