Option Strategies
Calendar Spreads

Diagonal or Regular

January Sell Put ( sell is in the front month ) 

March Buy Put ( same strike and type ) 

 

  • – Sell near-term Put/Call 

  • – Buy longer-term Put/Call 

  • Both need same strike price and same type ( call/put ) 

  1. Put Calendar Spread is Bullish
  2. Call Calendar Spread is Bearish

Place in in LOW IV conditions 

Directional Assumption is NEUTRAL 

Sell with same strike and type 

The Trade Results in the Following:

  • Negative delta Positive theta – because decay in the front month is faster than the back month.  therefore this position benefits as time passes 
  • Positive vega – this position benefits from an increase in volatility 

Therefore, if the stock drops, the position will benefit 

  • The short strike in the front month will expire first and hopefully in the money 
  • At that time, you buy another strike in the next expiration — then rinse and repeat 
  •  
  • Buy 50/sell 55 september 
  • Roll 55 to october

A Long Calendar Spread is a low-risk, directionally neutral strategy that profits from the passage of time and/or an increase in implied volatility.  

Keeping this information in mind is most helpful when setting up the trade.  

Directional Assumption: Neutral Setup: A calendar is comprised of a short option (call or put) in a near-term expiration cycle, and a long option (call or put) in a longer-term expiration cycle. Both options are of the same type and use the same strike price. 

  • – Sell near-term Put/Call 
  • – Buy longer-term Put/Call 
  • Both need same strike price and same type ( call/put ) 

Max Profit: The maximum profit potential of a Calendar Spread can’t be calculated due to both options being in different expiration cycles. One of the most positive outcomes for a Calendar Spread is for the trade to double in price.  

  

How to Calculate Breakeven(s):The break-even for a calendar spread cannot be calculated due to the different expiration cycles being used. A guideline we use is within 1 strike of the Calendar Spread’s strike price. 

There are two things to remember when it comes to calendar spreads: 

  

1. If the stock price moves too far from our strikes, the trade will become a loser. 

2. An implied volatility increase will help our trade make money. 

  

Keeping this information in mind is most helpful when setting up the trade.  

 

  • We pick strikes that are near the stock price, if not right on the stock price.  

  • We may skew it slightly bullish or slightly bearish if we have a small directional assumption, but it will be very close to the stock price regardless – that gives us the most exposure to profit or loss with changes in implied volatility.  

  • You will only see us routing this strategy in the lowest of IV environments. 

  

 When do we close Calendar Spreads? 

 

Since a calendar spread can be hurt by too much stock movement, we tend to manage our winners at around 25% of the debit we paid to enter the trade. Waiting too long for additional profits could mean stock price movement, which is bad for the position. We never route calendar spreads in volatility instruments. Each expiration acts as its own underlying, so our max loss is not defined.  

  

When do we manage Calendar Spreads? 

 

  • Since this is a debit spread that is defined risk, we don’t usually manage these spreads.  

 

  • We are comfortable with the debit paid as max loss, and there’s not much we can do with these spreads regardless since they share the same strike. 

 

  • It seems to be a very attractive strategy: Buy an option that expires months in the future and then write calls against that option — and collect a new premium every month. Many beginners think of this as similar to writing covered calls month after month. 

   

Is this a conservative strategy? 

  

This is a strategy favored by some traders. Personally, I don’t use it and prefer alternatives. But please understand that each of us should use strategies that make us feel comfortable. There’s nothing inherently wrong with this idea.  I don’t consider this to be a conservative strategy. 

  

Advantages 

  

1. Time decay. Longer-term options have a smaller theta (rate at which option loses value as one day passes). That means the position you describe is expected to make a small amount of money every day, all things being equal (which they seldom are). 

  

2. Repeatability. If the short-term option expires worthless, or is repurchased at a small price ($0.05 or $0.10 for example), then you still own your long-term option and can sell a new, short-term option against it. If you can repeat this trade several times (once per month), by the time your long-term option becomes the front-month option (and time to sell it) you’ll have collected much more in time premium than you paid. And that makes the trade profitable. This is the ideal situation. 

  

Disadvantages:  This is a Quandary of Adjustment Nightmares 

  

Price movement. 

  

1. When the stock moves much lower and you have a call spread (or higher and you own a put spread), the value of your long-term option declines by far more than you collected when selling the front-month call. 

  

Thus, at the first expiration, you’re already losing money. You must now sell another option against your long option. Which strike price do you sell? If you own a call with a 60 strike price and the stock is down to 52, do you sell the 55 call — risking a move to the upside? Do you sell the 60 call, which will be a low-priced option and give you little chance to make much money — unless the stock rallies back toward 60. This is a problem. 

  

2. If the stock rallies to 70 instead of falling, the spread loses money because the price of the near-term option increases more rapidly than the price of your longer-term option. When you buy back your short-term call (when expiration arrives), you must decide which option to sell next. If you sell another call with a strike of 60, it will have little time premium and your chance for making money is going to depend on the stock price falling back toward 60. 

  

If, instead, you choose to sell a call with a 70 strike price (in other words, an at-the-money call), you have a chance to make some decent money and recover the loss. But, if the stock price declines back to 60, you’re worse off than when you started (because you paid far more to buy back the 60 call at the previous expiration than you collected for the recently written 70 call). 

  

Bottom Line 

  

  • You have good time decay with the position. 

  • You have negative gamma, and any decent-size move is going to take away your profits. 

  • Any-time spread has the same properties, but when you own a long-term option, the risk and reward are both magnified.  

  • Calendar spreads with only one month separating the expiration dates is far more conservative — and in that respect is very different from the spread you describe.