Strategy

calendar spread

Type of Strategy

trading      /      potentially investing

sentiment

generally neutral but can be skewed

implied volatility

low

description

A defined risk strategy consisting of equivalent options except for expiry, with the short leg in the near month expiry and the long option in the further dated cycle.  Calendar spreads benefit from time-decay as the near-term option loses value at a faster rate than the far-term option.

Set-Up

Purchase a longer-dated call/put option and sell a nearer-term call/put option against the long position.  The options should be of the same type, on the same underlying, with the same strike price.

Calendar spreads are simple to execute, but complex in detailed understanding of performance.  Maximum profit and break-even points cannot be calculated due to the changing market conditions with options in two different expiration cycles.

Calendar spreads can be Neutral, Bearish, or Bullish, determined by strike price placement.

management

Traders generally set profit targets at approximately 25% of the purchase price of the spread.

Calendar spreads realize the greatest profits when the stock price lands on the short strike (near-term) position.  A rising IV environment generally improves spread performance.

variations

Spreads can be set up on monthly cycles, weekly cycles, or any combination of expirations provided the long option is the further-dated in the spread.

Traders generally use calendar spreads, although there may be select cases where a calendar spread might prove beneficial to an option investor.  Some traders commonly employ calendar spreads in short-term earnings trades, holding the spread for only a few days at most.

image from blog.quantinst.com

example – regn

Trader wishes to buy a calendar spread in Regeneron Pharmaceuticals (REGN)

1) In an offensive account (tax-free), sell a 23 DTE, 50 delta call option with a strike price of $460 for $14.05.

2) In an offensive account (tax-free), purchase a 58 DTE, 50 delta call option with strike price of $460 for $23.45.

3) Net cash usage for the position is $23.45-$14.05 = $9.40.  This is the maximum risk in the position.

Calendar Spread: REGN

management – regn

Once the spread has been purchased for $9.40, the trader establishes a GTC STC order for the spread at $11.75 (25% profit level on the $9.40 debit)

Beyond setting profit targets, there is little management available in a calendar spread.  As the spread nears expiry, the trader may adjust the sale price to gain maximal value from the position.

The financial return profile of a calendar spread is an imperfect approximation, as changing market conditions may significantly alter actual spread performance.