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What Are Calendar Spreads and How Do They Work?

By Mike Zaccardi, CMT, CFA · February 17, 2022 · 5 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What Are Calendar Spreads and How Do They Work?

Many options spread strategies consist of buying and selling call or put options that expire at the same time. Calendar spreads, on the other hand, are created by selling a short-dated option and buying a longer-maturity option with the same strike price. Rather than seeking favorable directional movement in the underlying stock, the calendar spread takes advantage of implied volatility and the way that it typically changes over time.

Like other option spread strategies, a calendar spread limits a trader’s potential losses, but it also caps their potential return. Calendar spreads are considered an advanced option trading strategy, so it’s important to have a handle on how they work and the potential risks. Read on to learn more about how to build calendar spreads and when to use them.

Calendar Spreads Defined

A calendar spread, also known as a horizontal spread, is created with a simultaneous long and short position in options on the same underlying asset and strike price but different expiration dates. Calendar spreads can be constructed using calls or puts. The longer-dated option is purchased and the shorter-dated option is sold. Typically, the option that is sold has a near-term expiration date.

How Calendar Spreads Work

Calendar spreads are typically established for a net debit, meaning you pay at the outset of the trade. This is because generally speaking, a longer-dated option will be more expensive than a shorter-dated one if the strike prices are the same.

Time decay is essential to how calendar spreads work. It tends to accelerate as an option’s expiration approaches, which means that all else equal, the short-dated option will lose more value due to time decay than the long-dated option over a given passage of time. If the stock price is at or near the strike price of the options at the time of the first expiration date, the trade should be profitable.

Calendar spreads function fairly similarly whether constructed with calls or puts. Depending on where the stock price is relative to the strike price selected at the outset of the trade, and whether calls or puts are used, a calendar spread can be neutral, slightly bearish, or slightly bullish.

Maximum Profit on Calendar Spread

A calendar spread strategy hits max profit when the stock price settles at the near-term strike price by that option’s expiration. That is not the end of the trade, however. The trader benefits when the stock price rises after the near-dated option’s expiration since they are long the later-date call option.

A rise in implied volatility after the front-month call expires also benefits the later-dated long options position. However, some traders might choose to close the later-dated option position when the near-dated option expires.

Maximum Loss on Calendar Spread

A calendar spread is considered a debit spread since the cost of the later-dated option is greater than the proceeds from the near-date option’s sale. So the trader can not lose more than the premium paid.

Breakeven

The precise breakeven calculation on a calendar spread option trade cannot be determined due to the two different option delivery dates. Traders must estimate what the value of the long-dated option contract will be on the near-dated option’s expiry.

One way to this is using online option strategy profit and loss calculator to estimate a breakeven price. Changing option Greeks – such as implied volatility levels and market interest rates – also make deriving a breakeven price difficult to pin down on this strategy.

Calendar Spread Example

An example helps to understand how calendar spread options work. Suppose XYZ stock is $100, and the trader believes the stock price will not change much in the next month. Based on that neutral thesis, the trader sells a $100 call option expiring in one month for $10 and buys a call at the same $100 strike price that expires in two months at a price of $15. The net debit is $5. The later-dated call option is more expensive because it has more time value than the near-dated call.

Over the next month, the stock fluctuates since the trade was executed, but settles back to $100 on the afternoon of the front-month’s option delivery date. Since time has passed and the stock has not drifted from $100, the near-dated call option has lost considerable time value. The short call expires worthless. The later-dated call is now worth $10.

The trade worked well. The trader exits the position by allowing the near-term call to expire worthless and selling to close the $10 later-dated long call. In essence, the trader made $10 on the short call and lost $5 on the long call for a profit of $5.

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Calendar Spread Payoff Diagram

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Source: https://www.warriortrading.com/calendar-spread-definition-day-trading-terminology/

Calendar Spread Risks

There are several risks that traders must keep in mind when using calendar spreads.

Limited Upside

This is the main risk in calendar spread strategies, if the trade closes at the near-dated option’s expiry. The options trader benefits from time decay and increases in implied volatility. Once the short option expires or is bought to close, there is unlimited upside potential with the remaining long call. If the trader uses puts they have a significant upside if the stock price goes to zero.

Delivery Dates

Trader must make a choice when the near-dated option is on the precipice of expiring. The trader can let it expire if it is out of the money, but if it is in the money, then it might be worthwhile to buy to close the option.

Timing the Trade

Being correct about the near-term direction of the stock, as well as changes in implied volatility and time decay, can be challenging.

Types of Calendar Spreads

There are several types of calendar spreads. Here’s a look at some of the most popular strategies.

Put Calendar Spread

A calendar put spread option is a strategy in which a trader sells a near-dated put and buys a longer-dated put. A trader would put this trade on when they are neutral to bullish on the price change of the underlying stock in the near-term. Once again, this type of calendar spread options strategy aims to benefit from time decay or higher implied volatility.

Calendar Call Spread

A calendar call spread involves shorting a near-term call and buying a longer-dated call at the same strike. (This is the strategy outlined in the earlier example.) The near-term outlook on the underlying stock is neutral to slightly bearish while the trader might have a longer-term bullish view.

Diagonal Calendar Spread

A diagonal calendar spread uses different strike prices for the two options positions. This strategy still uses two options – either two calls or two puts – with different expiration dates. This strategy can be either bullish or bearish depending on how the trade is constructed. The term diagonal spread simply refers to the use of both a calendar spread (horizontal) and a vertical spread.

Short Calendar Spread

Traders can use a short calendar spread with either calls or puts. It is considered a “short” calendar spread options strategy because the trader buys the near-dated option while selling the longer-dated option. This is the opposite of a long calendar spread. A short calendar spread profits from a large move in the underlying stock.

Trading Stocks with SoFi

Calendar spreads are useful for traders who want to profit from changes in stock variables other than price direction. They’re an advanced strategy, however, that may not make sense for beginner investors.

However, you do not need to use any options at all to build a portfolio that helps you meet your goals. SoFi does not currently offer options, but it does provide an easy way to start building a portfolio. By opening an online brokerage account on the SoFi Invest® investment app, you can start trading in individual equities, fractional shares, and exchange-traded funds (ETFs) directly from your phone.

Photo credit: iStock/Tatomm


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