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Calendar Spread Strategy

The calendar spread is a more complex strategy than a vertical spread, which probably explains why so many avoid it. However, it doesn't have to be that intimidating once you understand some of the mechanics.

Construction Made up of 1 long option and one short option with the same strike price but different months. The short strike will be nearer month while the long strike price will be a further out month.
Example Long March 38 call + Short Feb 38 call

Long March 30 put + Short Feb 30 put
  • Put on for a debit
  • Benefits from time passing
  • Benefits from increasing volatility
  • Defined risk trade
  • Profit realized on closing the trade
Max Gain Difficult to determine. Could be as much as twice the initial debit or more.
Max Loss Initial debit

This strategy works because it takes advantage of the fact that options in different timeframes decay at different rates. An option contract with only 4 weeks remaining will decay in value at a much quicker rate than the same strike option contract with 8 weeks remaining (all other factors remaining the same).

Here's a quick example of a calendar spread. With about 4 weeks to go until March expiration, I would buy the April 45 call and sell the March 45 call of some stock, ETF or index. I might instead decide to put on a calendar by buying the April 40 put and selling the march 40 put. Both of these trades would be initially entered with a debit.

The way money is made with this spread is to have the March option expire as close to the short strike as possible. So, with the put calendar, having the March 40 put expire with the stock just above $40 would be ideal. The March 40 put would be nearly worthless while the April 40 put would be still worth something - almost certainly more than the initial debit. I can then close the April 40 put for a net profit.

A similar approach would be used for the call calendar spread. Even though the ideal place for the spread to end is right at the short strike price, there is actually a fairly wide range in price where the spread will be profitable to some degree.

One of the interesting things about calendar spreads is that they actually benefit from a rise in volatility. Since a rise in volatility usually accompanies a fall in the underlying stock, I prefer to only trade put calendars.


This strategy is a much more neutral strategy for the medium term. That means I would expect the stock to not move significantly up or down for the 2-3 months I am in the trade. This is a very suitable strategy in cases where I expect the stock, ETF or index to stay in a range.

Ideally, I want to enter the position when volatility is relatively low and close or roll the position when volatility is higher.

QQQQ calendar spread example

In this example of the QQQQ chart, the ETF has been trading somewhat in a range for the last several months and is currently just over $30. I might decide to buy a call calendar spread above the current price or buy a put calendar below the current price. As I mentioned, I prefer to buy put calendars because they are more likely to experience a volatility increase as the stock comes down to meet my short put strike.

I want to take just a quick moment to address why this type of trade benefits from volatility increases AND the passage of time simultaneously.

To understand this, let's imagine I've sold a March 28 put and simultaneously bought an April 28 put on the QQQQ. With about 4 weeks to expiration, the March 28 put is worth about $.38. With around 8 weeks to expiration, the April 28 put is worth about .78 making the net cost of this calendar about $.40.

Now, let's theoretically move forward in time about 3 weeks leaving the March 28 put only a week away from expiration and the April 28 put 5 weeks away. In the time that has passed, the QQQQ has dropped $3 and volatility has increased about 2.5%. Because of the drop in price, the March 28 put has risen in value to $.63 while the April 28 put has risen to $1.52 leaving the spread worth $.89. That's a 134% return on investment in 3 weeks!!

What happened? With the passage of time, the March 28 put has begun to lose value faster than the April 28 put. Also, volatility will affect the back month option prices more than the front month. This would make sense since market makers would be less certain about the future price of a stock farther out in time. To compensate for their uncertainty, they will inflate the time value portion of the option price.

The beauty of a calendar spread is that even if the stock was at the exact same price in 3 weeks, I'd still have made money on that trade simply due to the front month time premium melting away faster than the back month. When I combine time passing with the stock moving toward my short strike accompanied by an increase of volatility, I can have a really nice trade.

Update 3/20/2009: I actually placed a 1 contract order of this trade just to see what would happen. I entered on 2/13/2009 for a debit of $.42 with QQQQ trading at just over $30 and closed the trade on 3/16/2009 for a credit of $.78 with QQQQ trading at just over $28, leaving a net profit before commission of $.36. This trade actually yielded an 85% return on my original investment.

Trade Entry

Selecting the right stock

You can trade calendar spreads on any stock, ETF or index for which you have a neutral to mildly bullish or bearish outlook on. I prefer to trade ETFs because in addition to being highly liquid, they are less affected by earnings and other corporate events or surprises.

I like to pick an ETF that has begun trading in a range. Since this is potentially a medium term trade, I like to step back and look at history and see what kind of cycles it goes through. How long does it trend up or down? How long will it trend in a sideways channel?

Timing the entry

Timing on the entry of a calendar is less critical than in other strategies. When looking for an ETF to trade a put calendar on, I'll look for two things. First, I'd prefer to see that ETF trading near the top of its range since the odds favor it reversing to head toward the lows of the range. Second, I'd like to also see volatility be relatively lower than when it is at the lower end of its range. Both of these give me a better advantage of benefiting when the stock does move toward the lower part of the range.

Selecting the right options

When I'm researching a potential calendar spread, there are several factors I consider.

  1. I'd like to make sure that I can find a strike price that is about 2-3 strikes below the current price and near the bottom of the trading range.
  2. I like to make sure that average implied volatility of the front month is slightly higher than for the back month. This can give me a slight edge since the option I'm selling will have a higher premium.
  3. I also like to look at trading multiple months vs just a single month spread.
There are several advantages of spanning multiple months. Many times a spread spanning multiple months will have a cheaper 'per month' cost than a single month. In addition, having a multiple month spread means I can roll the front month to the next month and collect additional premium.

Continue to Calendar Spread - page 2

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