What Is A Calendar Spread

What Is A Calendar Spread?

A calendar spread is an options strategy that entails buying and selling a long and short position on the same stock with the same strike price but different expiration dates. 

In most calendar spreads, a trader purchases a longer-dated options contract and sells a short-term options contract at the same strike price. 

Quick Facts

• A Calendar Spread is a trading strategy that involves simultaneously buying and selling an options or futures contract at the same strike price but with different expiration dates.
• Calendar Spreads benefit from Theta Decay on the sold contract and positive Vega on the long contract.
• Calendar Spreads are typically most profitable when there is little to no volatility in the underlying asset until after the sold contract has expired. 
• The short position is Theta positive, and the long contract experiences Theta Decay.
• Using this strategy, a trader with a long-term bullish outlook can reduce the premiums paid for entering a long call position by selling a short-dated options contract. 

How Do Calendar Spreads Work?

A calendar spread works by selling an options contract with a short-dated expiration and purchasing another options contract with a longer expiration date. The premium received from the sale of the short option is used to offset the cost of the long option. This strategy can be used with calls and puts. Typically both contracts are of the same type and of the same strike price. 

These trades are profitable because the theta decay on the short-term option decays faster than the long option, especially if the long option has an expiration date of several months out. 

After the short position expires, the trade is now a long call and will experience greater theta decay as expiration approaches. 

Types Of Calendar Spreads

Call Calendar Spread

This options strategy involves selling a short-term call contract and buying a longer-dated call contract at the same strike price. This strategy would be used if a trader’s outlook is neutral in the short term and bullish in the long term. This type of strategy benefits from time decay and implied volatility.

Put Calendar Spread

This is an options strategy that involves selling a near-dated put and buying a longer-dated put contract. This strategy is used when the short-term outlook on a stock is neutral and the long-term outlook is bearish.

Diagonal Calendar Spread

A diagonal calendar spread involves buying and selling two contracts of the same type, with different strike prices and different expiration dates. This strategy can be structured to be either bullish or bearish, depending.

Short Calendar Spread

A short calendar spread buys the short-dated contract and sells the long-dated contract. This type of calendar spread is used when a significant move in the underlying asset is expected in the near term.

Neutral Calendar Spread

This strategy is used when a trader has a neutral outlook on the underlying asset and is looking to benefit from the time decay of the short-dated option. This strategy can be used with calls or puts.

When Can Calendar Spreads Be Used

This type of options strategy benefits from theta decay on the short-term option and Vega, or volatility, in the longer-dated option. In order for a calendar spread to be profitable, the short options contract needs to expire worthlessly. This implies that the short options contract would stay at or below the strike price until expiration. 

If the long options contract sees an increase in volatility or is Vega positive, it may see a rise in premium that offsets theta decay. 

Some traders will use a calendar spread strategy when they expect a stock to trade sideways in the short term and have a larger move close to the date of the long option.

For example: If an underlying stock has been trending neutral or sideways for some time but is expected to have a run into earnings, a calendar spread can be used to benefit from the sideways movement of the stock now, and the rise of the implied volatility closer to the earnings report/expiration. 

What Is The Maximum Loss On An Options Contract?

Because this strategy is known as a debit spread, the maximum loss possible is the debit paid to initiate the trade. 

Risk Of Early Assignment

When a trader has sold any options contract, there is always the possibility of early assignment.

Early assignment typically happens when a short option is in the money. Early assignment can also happen upon an upcoming dividend payment. Traders should be cautious when selling options to ensure no dividend payment is scheduled. 

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