What is a Calendar Spread in Stock Options Strategies?

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There are many options strategies that a trader can apply while dealing in stock options contracts. One such option strategy is the Calendar Spread where selling an option and buying one takes place at the same time. The option that is sold is usually short term, while the one bought is a longer-term call or put option. Needless to say, a calendar spread requires the options to be of the same strike price and have the same underlying assets.

A calendar spread strategy is utilized when there is no movement in the market or when there is no movement to hedge the risks that emanate from the fluctuation of the price of the underlying asset.

More about Calendar Spread

Sometimes called a "horizontal spread", a calendar spread takes into account the time difference of options’ expiry to earn some profit. It lets the traders cash in from the stock price movements at limited risks when market trends reverse.

The traders usually take advantage of the implied volatility to estimate the market movement within a specific time period with the price and underlying assets remaining the same but deadline changing simultaneously.

Long Calendar Spread

It is also known as "time calendar spread" where buying and selling of a call option or buying and selling of a put option occur where the expiry dates of the options are different but all other characteristics are the same. When the trader sells a short-dated option and buys a long-dated one, he spends less than if the option is bought upright. This is a premium the traders can enjoy from the selling and consequently buying the options.

There are two types of long calendar options – put and long. A put option has certain advantages over call options and there are different timings of executing these options. The usual rule is to execute a call option when the market is bullish, while the put option should be executed when the market is bearish.

Making Money from Calendar Spread Strategy

There are basically two ways of earning money from a long calendar strategy.

  • Earning money from time decay

  • Income generated from increased/decreased volatility

As short-term options lose value more rapidly than long-term ones, traders having expert knowledge can sell short-term options and buy long-term ones to profit from the gap between the deadlines of the two types of options. The situation of differently timed options offering a sideway income is known as the "time decay premium of the options."

An increase in volatility of long-term options and decrease in the volatility of short-term ones are also possible with a long calendar strategy. However, this needs analysts who have studied the market long enough to correctly anticipate the market movements.

Updated on 27-Oct-2021 05:37:09