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Calendar Spread

Calendar Spread
TradingOptions and Derivatives TradingOptions and Derivatives

What Is a Calendar Spread?

A calendar spread is an options or futures strategy laid out by simultaneously entering a long and short position on a similar underlying asset yet with various delivery dates.

In a run of the mill calendar spread, one would buy a longer-term contract and go short a nearer-term option with the equivalent strike price. In the event that two different strike prices are utilized for every month, it is known as a diagonal spread.

Calendar spreads are some of the time alluded to as between delivery, intra-market, time spread, or horizontal spreads.

Understanding Calendar Spreads

The normal calendar spread trade includes the sale of an option (either a call or put) with a close term expiration date and the simultaneous purchase of an option (call or put) with a longer-term expiration. The two options are of a similar type and typically utilize a similar strike price.

  • Sell close term put/call
  • Buy longer-term put/call
  • Ideal yet not required that implied volatility is low

A reverse calendar spread takes the contrary position and includes buying a short-term option and selling a longer-term option on a similar underlying security.

Special Considerations

The purpose of the trade is to profit from the progression of time as well as an increase in implied volatility in a directionally neutral strategy.

Since the goal is to profit from time and volatility, the strike price ought to be essentially as close as conceivable to the underlying asset's price. The trade exploits how close and long-dated options act when time and volatility change. An increase in implied volatility, any remaining things held something similar, would decidedly affect this strategy since longer-term options are more sensitive to changes in volatility (higher vega). The caveat is that the two options would be able and most likely will trade at various implied volatilities.

The progression of time, any remaining things held something similar, would decidedly affect this strategy toward the beginning of the trade until the short-term option lapses. From that point onward, the strategy is just a long call whose value disintegrates as time slips by. As a rule, an option's rate of time decay (theta) increases as its expiration moves nearer.

Maximum Loss on a Calendar Spread

Since this is a debit spread, the maximum loss is the amount paid for the strategy. The option sold is nearer to expiration and subsequently has a lower price than the option bought, yielding a net debit or cost.

The ideal market move for profit would be a consistent to somewhat declining underlying asset price during the life of the close term option followed by a strong move higher during the life of the far-term option, or a sharp move up in implied volatility.

At the expiration of the close term option, the maximum gain would happen when the underlying asset is at or somewhat below the strike price of the lapsing option. Assuming that the asset were higher, the terminating option would have intrinsic value. When the close term option lapses worthless, the trader is left with a simple long call position, which has no upper limit on its possible profit.

Basically, a trader with a bullish longer-term outlook can reduce the cost of purchasing a longer-term call option.

Illustration of a Calendar Spread

Expect that Exxon Mobile (XOM) stock is trading at $89.05 in mid-January, you can go into the accompanying calendar spread:

  • Sell the February 89 call for $0.97 ($97 for one contract)
  • Buy the March 89 call for $2.22 ($222 for one contract)

The net cost (debit) of the spread is subsequently (2.22 - 0.97) $1.25 (or $125 for one spread).

This calendar spread will pay off the most assuming XOM shares remain generally flat until the February options terminate, permitting the trader to collect the premium for the option that was sold. Then, at that point, in the event that the stock moves up between, and March expiry, the subsequent leg will profit. The ideal market move for profit would be at the cost to turn out to be more unstable in the close to term, however to generally rise, closing just below 95 as of the February expiration. This permits the February option contract to terminate worthless regardless permit the trader to profit from up climbs until the March expiration.

Since this is a debit spread, the maximum loss is the amount paid for the strategy. The option sold is nearer to expiration and in this manner has a lower price than the option bought, yielding a net debit or cost. In this scenario, the trader is expecting to capture an increase of value associated with a rising price (up to yet not past $95) among purchase and February expiration.

Note that assuming the trader were to just buy the March expiration, the cost would have been $222 dollars, however by utilizing this spread, the cost required to make and hold this trade was just $125, making the trade one of greater margin and less risk. Contingent upon which strike price and contract type are picked, the calendar spread strategy can be utilized to profit from a neutral, bullish, or bearish market trend.

Features

  • A calendar spread is most profitable when the underlying asset takes no critical actions in one or the other course until after the close month option lapses.
  • A calendar spread is a derivatives strategy that includes buying a longer-dated contract to sell a shorter-dated contract.
  • Calendar spreads permit traders to develop a trade that limits the effects of time.