Calendar spreads options trading strategies

The calendar spread options strategy.

Here's how to capture opportunities created by volatility with the calendar spread.

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Trading Active Trader Pro Brokerage Options.

Trading Active Trader Pro Brokerage Options.

Trading Active Trader Pro Brokerage Options.

The calendar spread options strategy is a market neutral strategy for seasoned options traders that expect different levels of volatility in the underlying stock at varying points in time, with limited risk in either direction. The goal is to profit from a neutral or directional stock price move to the strike price of the calendar spread with limited risk if the market goes in the other direction.

What is a calendar spread?

A calendar spread typically involves buying and selling the same type of option (calls or puts) for the same underlying security at the same strike price, but at different (albeit small differences in) expiration dates. This type of strategy is also known as a time or horizontal spread due to the differing maturity dates.

A typical long calendar spread involves buying a longer-term option and selling a shorter-term option that is of the same type and exercise price. For example, you might purchase a two-month 100 strike price call and sell a one-month 100 strike price call. This is a debit position, meaning you pay at the outset of the trade.

Calendar spreads are for experienced, knowledgeable traders.

The goal of a calendar spread strategy is to take advantage of expected differences in volatility and time decay, while minimizing the impact of movements in the underlying security. The objective for a long call calendar spread is for the underlying stock to be at or near, nearest strike price at expiration and take advantage of near term time decay. Depending on where the stock is relative to the strike price when implemented the forecast can either be neutral, bullish or bearish.

Calendar spread candidates.

You can use some of the tools that are available on Fidelity to search for calendar spread opportunities. For example, if you select “IV 30 > HV 30” as the criterion, the scan will look for elevated IV levels relative to historical volatility (HV) levels. This specific screen may indicate that certain options are “expensive.”

One-year implied volatility chart.

Profit/loss breakdown.

The profit/loss diagram of a calendar spread shows that when the stock price increases, this type of trade suffers. Significant movement in either direction in a short period may be costly because of the way the higher gamma (the rate of change, or sensitivity, to a price change in the underlying security for delta) affects short-term contracts.

Another risk to this position is early assignment when selling shorter-term contracts (especially with calls), where the expiration date follows the ex-dividend date. If this is the case, the probability of assignment increases significantly. If assignment occurs prior to the ex-dividend date, the client will owe the dividend payment because the account is now short shares, unless shares of the underlying security are already held in the account.

Early assignment also changes the strategy from a calendar spread to a synthetic long put if you don’t already own shares, because you are short a stock and long a call, which is a very different outlook.

Managing a calendar spread.

It is also advisable to check for ex-dividend dates, as it is very important to understand assignment risk—especially for call spreads. You can adjust the spread as necessary to maintain the long position, while adjusting the strike price of the short contract along the way to give more delta exposure.

Calendar spreads with Fidelity.

When the short-term expiration date approaches, you will need to make a decision: Sell another front-month contract, close the whole strategy, or allow the long-term call or put to stay in place by itself.

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Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options. Supporting documentation for any claims, if applicable, will be furnished upon request.

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How to Trade the Calendar Spread: Options Trading Strategy for Income.

We have discussed the definition of two options trading income strategies before: the short vertical spread and the iron condor.

In this article we would like to introduce you to another options strategy called the “calendar spread” which is also known as the “time spread”. Like the short vertical spread, when employing the calendar spread strategy, we are selling one option and hedging it with another option. In the case of the vertical spread, the option contract we are selling is more expensive than the option we are buying and that is the reason these are also called credit spreads.

Both options contracts expire on the same date as they are in the same option expiration series. With the calendar spread however we are going to sell one option contract and hedge it using another option at the same strike price, but in a later dated expiration cycle. In this case, because we are selling a nearer term option which is less expensive than the option we are buying (because the later term option at the same strike price will always have more time premium than the nearer term option contract at the same strike price) this would be done at a debit.

The calendar spread therefore has some similarities to the covered call strategy in which you own a stock and then sell the ATM call option for that stock “against” your long shares. In the case of a calendar spread strategy, we are using the longer dated option instead of the stock.

Let’s take a look at an example.

For the purpose of this illustration, IBM is trading at $200. To set up a calendar spread trade we would sell the 30 day option for $4.00 and then buy the 60-day option at the same strike price for $6.50. Thus our cost would be $2.50 or $250 total. This cost is our entire risk in the trade. The best case scenario for us, if we held the trade until the 30-day option expired, would be for IBM to stay right at $200.

If everything stayed the same, our 30-day option would be worthless and our 60-day option would have 30 days left to expiration and be worth approximately $4.00 according to standard options valuation models. So we would make a $1.50 profit on a $2.50 investment or 60% return. However, this is just an example and not a recommended trade plan. A typical option trade plan for income might include just taking a slice of the 60% potential return, perhaps exiting when you get to a 10% to 15% return.

In some cases, you can achieve this lower level of return in in a very short period of time—three to five market days. This lower objective is still a great return, of course, and if you do to choose to exit, you have ended your risk of being exposed to market volatility and potentially “giving back” the profits that you attained.

Prior to the introduction of weekly options, many income traders would initiate these types of options trades with 25–35 days prior to expiration of the front month. Now that weekly options have become popular, traders have developed many new ways of trading calendar spreads. One method would be to choose a long at-the-money option in the regular monthly expiration cycle options chain and sell the weekly option of the same strike that expires in the nearest week “against” that monthly option.

When that options trade is closed, we open a new trade in the same monthly option cycle but use the at-the-money option in the most current weekly options series, again at the same strike price as the monthly option that we are buying.

In the first example, the monthly option you bought might have 44 days to expire and the weekly option you sold might have nine days before it expires. In the next week, the monthly option would only have, say, 37 days and the new weekly option would have nine days again, as we are using a new cycle, which has nine days until expiration. So the prices you would be paying each time you “refreshed” the trade would tend to change as the long dated option comes down in price.

Another approach is to sell the front weekly option and then always buy the option one or two weeks longer dated than the front week. One advantage of this approach is that you become very familiar with the prices you are paying every week because the time until expiration in both options is always the same, whereas the variations in pricing are more pronounced when selling against a monthly long option.

Regardless of when in the expiration cycle you initiate calendar spread strategies, they present another opportunity to sell options for income while having a hedge to limit your losses. Calendar spreads offer a solid reward to risk, providing you with the potential ability to exit soon after trade inception, capturing an attractive portion of the possible reward.

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Pencil In Profits In Any Market With A Calendar Spread.

When market conditions crumble, options become a valuable tool to investors. While many investors tremble at the mention of the word "options", there are many option strategies that can be used to help reduce the risk of market volatility. In this article we are going to examine the many uses of the calendar spread, and discuss how to make this strategy work during any market climate.

a market-neutral position that you can roll out a few times to pay the cost of the spread while taking advantage of time decay or, a short-term market-neutral position with a longer-term directional bias that is equipped with unlimited gain potential.

Either way, the trade can provide many advantages that a plain old call or put cannot provide on its own.

Long Calendar Spreads.

There are two types of long calendar spreads: call and put. There are inherent advantages to trading a put calendar over a call calendar, but both are readily acceptable trades. Whether you use calls or puts depends on your sentiment of the underlying investment vehicle. If you are bullish, you would buy a calendar call spread. If you are bearish, you would buy a calendar put spread.

If the trader still has a neutral forecast, he or she can choose to sell another option against the long position, legging into another spread. On the other hand, if the trader now feels the stock will start to move in the direction of the longer-term forecast, he or she can leave the long position in play and reap the benefits of having unlimited profit potential. To give you an example of how this strategy is applied, we'll walk through an example.

Planning the Trade.

This strategy can be applied to a stock, index or ETF that offers options. However, for the best results, consider a vehicle that is extremely liquid, with very narrow spreads between bid and ask prices. For our example, we will use the DIA, which is the ETF that tracks the Dow Jones Industrial Average.

Looking at a five-year chart (Figure 1), you can see that recent price action indicates a reversal pattern known as the head-and-shoulders pattern. Prices have recently confirmed this pattern, which suggests continued downside. (For more insight, see Analyzing Chart Patterns: Head And Shoulders .)

If you look at a one-year chart, you'll see that prices are oversold, and you are likely to see prices consolidate in the short term. Based on these metrics, a calendar spread would be a good fit. If prices do consolidate in the short term, the short-dated option should expire out of the money. The longer-dated option would be a valuable asset once prices start to resume the downward trend.

Based on the price shown in the chart of the DIA, which is $113.84, we'll look at the prices of the July and August 113 puts. Here is what the trade looks like:

Bought September DIA 113 Puts: -$4.30 Sold July DIA 113 Puts: +$1.76 Net Debit: $2.54.

Upon entering the trade, it is important to know how it will react. Generally speaking, spreads move much more slowly than most option strategies. This is because each position slightly offsets the other in the short term. If the DIA remains above $113 at July's expiration, then the July put will expire worthless, leaving the investor long a September 113 put. In this case, you will want the market to move as much as possible to the downside. The more it moves, the more profitable this trade becomes.

If prices are below $113, the investor can choose to roll out the position at that time, meaning they would buy back the July 113 put and sell an August 113 put. If you are increasingly bearish on the market at that time, you can leave the position as a long put instead.

The last steps involved in this process are to establish an exit plan and to make sure you have properly managed your risk. A proper position size will help to manage risk, but a trader should also make sure that they have an exit strategy in mind when taking the trade. As it stands, the max loss in this trade is the net debit of $2.54. (For more, see Trading The QQQQ With In-The-Money Put Spreads .)

Pick Expiration Months as for a Covered Call.

By treating this trade like a covered call, it will help you pick expiration months quickly. When selecting the expiration date of the long option, it is wise to go at least two to three months out. This will depend largely on your forecast. However, when selecting the short strike, it is a good practice to always sell the shortest dated option available. These options lose value the fastest, and can be rolled out month-to-month over the life of the trade.

Leg Into a Calendar Spread.

Plan to Manage Risk.

Like any trading strategy, it is important to know the risks and downsides involved.

Limited Upside in the Early Stages.

Be Aware of Expiration Dates.

Time Your Entry Well.

The last risk to avoid when trading calendar spreads is an untimely entry. In general, market timing is much less critical when trading spreads, but a trade that is very ill-timed can result in a max loss very quickly. Therefore, it is important to survey the condition of the overall market and to make sure you are trading within the direction of the underlying trend of the stock.

When trading this strategy here are a few key points to remember:

Can be traded as either a bullish or bearish strategy Generates profit as time decays Risk is limited to the net debit Benefits from an increase in volatility If assigned, the trader loses the time value left in the position Provides additional leverage in order to make excess returns Losses are limited if the stock price moves dramatically.

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Neutral Option Strategies » Calendar Spread.

Calendar spreads are also known as time or horizontal spreads because they involve options with different expiration months.

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In this case, "horizontal" refers to the fact that option months were originally listed on the board at the exchange from left to right. At the same time, strike prices were listed from top to bottom. For this reason, options with different strike prices and the same expiration are often referred to as vertical spreads.

In simplest terms, a long calendar spread involves buying an option with a longer expiration and selling an option with the same strike price and a shorter expiration. For example, imagine that Dell Computer (DELL) is trading for $45 per share. To initiate a calendar spread, you might sell the Dell June 45 calls and buy the July 45 calls.

Like most long positions, there is a cost to put on this trade. In this case, the cost is $2. For the time spread to work, the June option must lose its time premium faster than the July option. If the stock price remains relatively stable as the June expiration approaches, the value of the spread should increase. With only one month remaining before the June expiration, the option prices might look like this.

In this case, the position could be closed for a one-point profit by selling the July calls and buying back the June calls.

For long calendar spreads to work, the underlying stock price must remain relatively stable. Any swings in either direction will negatively impact the time value of both options causing the spread to lose value.

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