Calendar Spread

What is a 'Calendar Spread'

A calendar spread is an options or futures spread established by simultaneously entering a long and short position on the same underlying asset at the same strike price but with different delivery months. Sometimes referred to as an inter-delivery, intra-market, time or horizontal spread.

The typical options trade comprises the sale of an option (call or put) with a near-term expiration date, and the simultaneous purchase of an option (call or put) with a longer-term expiration. Both options are of the same type and use the same strike price.

  • Sell near-term put/call
  • Buy longer-term put/call
  • Preferable but not required that implied volatility is low

The purpose of the trade is to profit from the passage of time and/or an increase in implied volatility in a directionally neutral strategy.

BREAKING DOWN 'Calendar Spread'

Since the goal is to profit from time and volatility, the strike price should be as near as possible to the underlying asset's price. The trade takes advantage of how near- and long-dated options act when time and volatility change. An increase in implied volatility, all other things held the same, would have a positive impact on this strategy because longer-term options are more sensitive to changes in volatility (higher vega). The caveat is that the two options can and probably will trade at different implied volatilities.

The passage of time, all other things held the same, would have a positive impact on this strategy in the beginning of the trade until the short-term option expires. After that, the strategy is only a long call whose value erodes as time elapses. In general, an option's rate of time decay (theta) increases as its expiration draws 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 closer to expiration and therefore has a lower price than the option bought, yielding a net debit or cost.

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

At the expiration of the near-term option, the maximum gain would occur when the underlying asset is at or slightly below the strike price of the expiring option. If the asset were higher, the expiring option would have intrinsic value. Once the near-term option expires worthless, the trader is left with a simple long call position, which has no upper limit on its potential profit.

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

Example of a Calendar Spread

With Exxon Mobile stock trading at $89.05 in mid-January, 2018:

  • Sell the February 89 call for $0.97 ($970 for one contract)
  • Buy the March 89 call for $2.22 ($2220 for one contract)

Net cost (debit) $1.25 ($1250 for one contract)