Calendar spreads, also known as time spreads, are one of the most useful options strategies. They allow traders to make directionally-biased trades at a lower cost basis than with outright purchases of puts or calls. This type of strategy is a market neutral strategy for seasoned options traders that anticipate different levels of volatility in the underlying stock at varying points in time, with limited risk in either direction. The key aim is to profit from a neutral or directional stock price shift to the strike price of the calendar spread with limited risk if the market goes in the other direction.

A calendar spread option trading strategy generally involves buying and selling similar type of option (calls or puts) for the same underlying security at the same strike price, but at different expiration dates. Due to the differing maturity dates, this type of strategy is also known as a time or horizontal spread. A calendar spread is said to be long if the trader buys the later month option and short if sells the later month options. As later month options have more time value and cost more, the trader will have pay for a long calendar spread and receive money for a short time spread.

Long Calendar Spreads

A long calendar spread, also known as a time spread, is the buying and selling of a call option or the buying and selling of a put option of the same strike price but different expiration months. There are mainly two types of long calendar spreads- call and put. The use calls or puts largely depends on the sentiment of the underlying investment vehicle. If the trader is bullish, he would buy a calendar call spread and if the trader is bearish, he would buy a calendar put spread.

A long calendar spread is an excellent strategy to use, especially when you expect prices to expire at the value of the strike price you are trading at the expiry of the front-month option. The strategy is ideal for a trader whose short-term sentiment is neutral.

Short Calendar Spreads

A short calendar spread is an option trading strategy that is designed to profit when a stock breaks out to upside or downside. The Short Calendar Spread does this by buying short term options and then writing higher premium long term options. This generates a credit spread where the trader receives money for putting on the position. In order to turn a profit, the underlying stock needs to move rapidly to either direction in order to diminish the premium on all the options. Afterwards, a profit is made on the difference between the decay of the short term options that has a lower premium and the long term options that has a higher premium. If the stock remained sluggish, the short term options would decay at a higher rate than the long term options and would as a result not return a profit.

Article by steadyoptions.com